PART B
THE BEAR STEARNS FUNDS
STATEMENT OF ADDITIONAL INFORMATION
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Prime Money Market Portfolio S&P STARS Portfolio Focus List Portfolio
Income Portfolio The Insiders Select Fund Balanced Portfolio
High Yield Total Return Portfolio Large Cap Value Portfolio International Equity Portfolio
Emerging Markets Debt Portfolio Small Cap Value Portfolio
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CLASS A, CLASS B, CLASS C AND CLASS Y SHARES
July 28, 2000, as revised on December 22, 2000
This Statement of Additional Information ("SAI"), which is not a
prospectus, supplements and should be read in conjunction with the current
relevant prospectus (the "Prospectus") dated July 28, 2000 of The Bear Stearns
Funds (the "Trust"), as each may be revised from time to time, offering shares
of the portfolios listed above (each, a "Portfolio"). To obtain a free copy of
such Prospectus, please write to the Trust at PFPC Inc. ("PFPC"), Attention:
[Name of Portfolio], P.O. Box 8960, Wilmington, Delaware 19899-8960; call the
Trust at 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. Marvin & Palmer Associates, Inc. (the "Sub-Adviser") has
been engaged to provide investment advisory services, including portfolio
management, to the International Equity Portfolio subject to the supervision of
BSAM. BSAM and the Sub-Adviser are collectively referred to herein as the
"Advisers."
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
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Investment and Management Policies.................................................... 1
Management of the Trust............................................................... 48
Management Arrangements............................................................... 50
Purchase and Redemption of Shares..................................................... 59
Determination of Net Asset Value...................................................... 64
Taxes................................................................................. 66
Dividends -- Money Market Portfolio................................................... 74
Portfolio Transactions................................................................ 74
Performance Information............................................................... 79
Code of Ethics........................................................................ 81
Information about the Trust........................................................... 82
Custodians, Transfer and Dividend Disbursing Agent, Counsel and Independent Auditors.. 90
Financial Statements.................................................................. 91
Appendix.............................................................................. A-1
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Each of the Portfolios described in this SAI, other than the Prime
Money Market Portfolio (the "Money Market Portfolio"), currently offers Class A,
Class B, Class C and Class Y shares. The Money Market Portfolio currently offers
only Class Y shares. The Portfolios, other than the Money Market Portfolio, may
be categorized as follows:
Fixed Income Funds:
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Income Portfolio
High Yield Total Return Portfolio ("High Yield Portfolio")
Emerging Markets Debt Portfolio ("EMD Portfolio")
Equity Funds:
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S&P STARS Portfolio
The Insiders Select Fund
Large Cap Value Portfolio ("Large Cap Portfolio")
Small Cap Value Portfolio ("Small Cap Portfolio")
Focus List Portfolio
Balanced Portfolio
International Equity Portfolio
The investment objectives and principal investment policies of each
Portfolio are described in the Prospectus. Each Portfolio's investment objective
cannot be changed without approval by the holders of a majority of such
Portfolio's outstanding voting shares (as defined in the Investment Company Act
of 1940, as amended (the "1940 Act")). A Portfolio's investment objective may
not be achieved. The following Portfolios are non-diversified: The Insiders
Select Fund and the S&P STARS, Focus List and EMD Portfolios. The other
Portfolios are diversified. See "Investment and Management Policies --
Management Policies -- Non-Diversified Status."
INVESTMENT AND MANAGEMENT POLICIES
The following information supplements and should be read in
conjunction with the sections in the Prospectus entitled "Risk/Return Summary,"
"Investments" and "Risk Factors." Unless otherwise stated, the indicated
percentage relates to a Portfolio's total assets that may be committed to the
stated investment, measured at the time the Portfolio makes the investment. New
financial products and risk management techniques continue to be developed, and
each Portfolio may use these new investments and techniques to the extent
consistent with its investment objective and policies.
Asset-Backed Securities. The Money Market, Income, High Yield, EMD,
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Balanced and International Equity Portfolios each may invest in asset-backed
securities. The High Yield and Balanced Portfolios each may invest up to 5% and
10%, respectively, of total assets in asset-backed securities. Asset-backed
securities represent participations in, or are secured by and payable from,
assets such as motor vehicle installment sales, installment loan contracts,
leases of various types of real and personal property, receivables from
revolving credit (credit card) agreements and other categories of receivables.
Such assets are securitized through the use of trusts and special purpose
corporations. Payments or distributions of principal and interest may be
up to certain amounts and for a certain time period by a letter of
credit or a pool insurance policy issued by a financial institution unaffiliated
with the trust or corporation, or other credit enhancements may be present.
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Like mortgage-related securities, asset-backed securities are often
subject to more rapid repayment than their stated maturity date would indicate
as a result of the pass-through of prepayments of principal on the underlying
loans. A Portfolio's ability to maintain positions in such securities will be
affected by reductions in the principal amount of such securities resulting from
prepayments, and its ability to reinvest the returns of principal at comparable
yields is subject to generally prevailing interest rates at that time. To the
extent that the Portfolio invests in asset-backed securities, the values of its
portfolio securities will vary with changes in market interest rates generally
and the differentials in yields among various kinds of asset-backed securities.
Asset-backed securities present certain additional risks that are not
presented by mortgage-related securities because asset-backed securities
generally do not have the benefit of a security interest in collateral that is
comparable to mortgage assets. Credit card receivables are generally unsecured
and the debtors on such receivables are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set-off certain amounts owed on the credit cards, thereby reducing the
balance due. Automobile receivables generally are secured, but by automobiles
rather than residential real property. Most issuers of automobile receivables
permit the loan servicers to retain possession of the underlying obligations. If
the servicer were to sell these obligations to another party, there is a risk
that the purchaser would acquire an interest superior to that of the holders of
the asset-backed securities. In addition, because of the large number of
vehicles involved in a typical issuance and technical requirements under state
laws, the trustee for the holders of the automobile receivables may not have a
proper security interest in the underlying automobiles. Therefore, there is the
possibility that, in some cases, recoveries on repossessed collateral may not be
available to support payments on these securities.
Any asset-backed securities held by the Money Market Portfolio must
comply with the portfolio maturity and quality requirements contained in Rule
2a-7 under the 1940 Act. The Money Market Portfolio will monitor the performance
of these investments and will not acquire any such securities unless rated in
the highest rating category by at least two nationally recognized statistical
rating organizations ("NRSROs").
Bank Obligations. Each Portfolio may invest in bank obligations.
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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"). State banking authorities supervise
and examine domestic banks organized under state law. State banks are members of
the Federal Reserve System only if they elect to join. In addition, a Portfolio
may acquire state bank-issued certificates of deposit ("CDs") that are insured
by the FDIC (although such insurance may not be of material benefit, depending
on the principal amount of the CDs of each bank that is held) 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 generally must, among other things, maintain specified levels of reserves,
limit the amounts they loan to a single borrower and comply with other
regulations 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 from 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
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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: (1) pledge a certain percentage of their assets, as fixed from time
to time by the appropriate regulatory authority, by depositing assets with a
designated bank within the state; 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, the Advisers carefully evaluate such investments on a case-by-
case basis.
Bank Debt. The High Yield and EMD Portfolios each may invest up to
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15% and 20%, respectively, of its total assets in Participations and
Assignments, defined below. Bank debt 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 that 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, including banks ("Lenders"). These investments
take 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 public and private debt securities and
from Assignments. In Participations, an investor has a contractual relationship
only with the Lender, not with the borrower. As a result, the investor 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, an investor 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 investor may not benefit
directly from any collateral supporting the loan in which it has purchased the
Participation. Thus, the investor 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, an investor 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 investor acquires direct rights against the
borrower, except that under certain circumstances such rights may be more
limited than those held by the assigning Lender.
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Participations and Assignments otherwise bear risks common to other
debt securities, including nonpayment of principal and interest by the borrower,
impairment of loan collateral and lack of liquidity. The market for such
instruments is not liquid and only a limited number of institutional investors
participate in it. The lack of a liquid secondary market may have an adverse
impact on the value of such instruments and will have an adverse impact on an
investor's ability to dispose of particular Assignments or Participations in
response to a specific event, such as deterioration in the creditworthiness of
the borrower. In addition to the creditworthiness of the borrower, an investor'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
investor and the borrower.
Borrowing. Each Portfolio, other than the EMD and Income Portfolios,
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may borrow in an amount up to 33-1/3% of its total assets (including the amount
borrowed), less all liabilities and indebtedness other than the borrowing. The
EMD Portfolio may, solely for temporary or emergency purposes, borrow in an
amount up to 15% of its total assets (including the amount borrowed), less all
liabilities and indebtedness other than the borrowing. The Income Portfolio
currently intends to borrow money only for temporary or emergency (net
leveraging) purposes, in an amount up to 15% of the value of its total assets. A
Portfolio may not purchase securities when borrowings exceed 5% of its total
assets.
Borrowings create leverage, a speculative factor. To the extent the
income derived from the assets obtained with borrowed funds exceeds the interest
and other expenses that a Portfolio will have to pay, the Portfolio's net income
will be greater than if borrowing were not used. Conversely, if the income from
the assets obtained with borrowed funds is not sufficient to cover the cost of
borrowing, the net income of the Portfolio will be less than if borrowing were
not used, and, therefore, the amount available for distribution to shareholders
as dividends will be reduced.
Brady Bonds. The Income, High Yield and International Equity
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Portfolios may invest in Brady bonds. Debt obligations commonly known as "Brady
bonds" 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. Brady bonds have been issued in connection with the restructuring of the
bank loans, for example, of the governments of Mexico, Venezuela and Argentina.
As a consequence of substantial volatility in commodity prices and a
dramatic increase in interest rates in the early 1980s, many emerging market
countries defaulted on syndicated bank loans made during the 1970s and early
1980s. Much of the debt owed by governments to commercial banks was subsequently
restructured, involving the exchange of outstanding bank indebtedness for Brady
bonds. They may be collateralized or uncollateralized and issued in various
currencies (although most are dollar-denominated) and are actively traded in the
over-the-counter secondary market. As a pre-condition to issuing Brady bonds,
debtor nations are generally required to agree to monetary and fiscal reform
measures prescribed by the World Bank or the International Monetary Fund,
including liberalization of trade and foreign investments, privatization of
state-owned enterprises and setting targets for public spending and borrowing.
These policies and programs are designed to improve the debtor country's ability
to service its external obligations and promote its growth and development.
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
with 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
supplemental interest payments but
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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 considered speculative.
Commercial Paper and Other Short-Term Corporate Obligations. Each
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Portfolio may invest in commercial paper and other short-term obligations.
Commercial paper consists of unsecured promissory notes issued by banks,
corporations and other borrowers. Such instruments are usually discounted,
although some are interest-bearing. Except as noted below with respect to
variable amount master demand notes, issues of commercial paper normally have
maturities of less than nine months and fixed rates of return. Variable rate
demand notes include variable amount master demand notes, which are obligations
that permit a Portfolio to invest fluctuating amounts at varying rates of
interest pursuant to direct arrangements between the 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, the Advisers 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 investment the borrower meets the criteria that the Trust's Board
of Trustees (the "Board") has established.
Convertible Securities. Each Portfolio, other than the Money Market
----------------------
and Focus List Portfolios, may invest in convertible securities. The Insiders
Select Fund and the Large Cap, Small Cap, Balanced and International Equity
Portfolios each may invest in convertible debt securities that are rated no
lower than "BBB" by Standard & Poor's ("S&P") or "Baa" by Moody's Investors
Service ("Moody's"), or if unrated by these rating organizations, determined to
be of comparable quality by the Advisers. The Balanced Portfolio may invest up
to 20% of its total assets in convertible securities.
Convertible securities include debt securities and preferred stock
that are convertible at stated exchange rates into the issuer's common stock.
Convertible securities generally offer lower interest or dividend yields than
non-convertible securities of similar quality. As with all fixed income
securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, to increase as interest rates decline.
When the market price of the common stock underlying a convertible security
exceeds the conversion price, however, the convertible security tends to reflect
the market price of the underlying common stock. As the market price of the
underlying common stock declines, the
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convertible security tends to trade increasingly on a yield basis, and thus may
not decline in price to the same extent as the underlying common stock.
Convertible securities rank senior to common stocks in an issuer's
capital structure and consequently entail less risk than the issuer's common
stock. The convertible securities in which a Portfolio may invest are subject to
the same rating criteria as the Portfolio's investments in non-convertible debt
securities. In the case of convertible security with a call feature, the issuer
may call the security at a pre-determined price. If a convertible security held
by a Portfolio is called, the Portfolio may permit the issuer to redeem the
security, convert it into the underlying common stock or sell it to a third
party. Convertible debt securities may be considered equity investments for
purposes of a Portfolio's investment policies.
Corporate Debt Obligations. Each of the Income and High Yield
--------------------------
Portfolios may invest 100% of its total assets in corporate debt obligations,
and each of the EMD, International Equity and Balanced Portfolios may invest up
to 70%, 35% and 60%, respectively, of its total assets in these securities.
Corporate debt obligations include obligations of industrial, utility and
financial issuers in the form of bonds, debentures, and notes. These securities
are subject to the risk of an issuer's inability to meet principal and interest
payments on the obligations and may also be subject to price volatility due to
such factors as market interest rates, market perception of the creditworthiness
of the issuer and general market liquidity. Except under conditions of default,
changes in the value of a Portfolio's fixed income securities will not affect
cash income derived from these securities but will affect the Portfolio's net
asset value.
Custodial Receipts. The High Yield Portfolio may invest in custodial
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receipts, and each of the Balanced and International Equity Portfolios may
invest up to 5% of its net assets in these instruments. Custodial receipts
evidence ownership of future interest payments, principal payments or both on
certain notes or bonds issued by the U.S. government, its agencies,
instrumentalities, political subdivisions or authorities. These custodial
receipts are known by various names, including "Treasury Receipts," "Treasury
Investors Growth Receipts" ("TIGRs"), and "Certificates of Accrual on Treasury
Securities" ("CATs"). For certain securities law purposes, custodial receipts
are not considered U.S. government securities.
Distressed Securities. The EMD Portfolio may invest in distressed
---------------------
securities and the High Yield Portfolio may invest up to 20% of its total assets
in these securities. Distressed securities are issued by financially troubled or
bankrupt companies ("financially troubled issuers") or companies whose
securities are, in the view of the Adviser, currently undervalued, out-of-favor
or price depressed relative to their long-term potential for growth and income
("operationally troubled issuers").
The securities of financially and operationally troubled issuers may
require active monitoring and at times may require the Adviser to participate in
bankruptcy or reorganization proceedings on behalf of a Portfolio. To the extent
that the Adviser becomes involved in such proceedings, a 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, no Portfolio invests 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 take any action to protect or enforce their
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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 an investor 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 Advisers will scrutinize any security interests, the
security interests may be challenged vigorously and found defective in some
respect, or a Portfolio may not be able to prevail against the challenge.
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 a Portfolio will attempt to avoid taking
the types of action that would lead to equitable subordination or creditor
liability, such claims may be asserted and the Portfolio may not be able to
defend against them successfully.
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, such claims may be asserted and a Portfolio may not be
able to defend against them successfully. To the extent that a 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.
Equity Securities. The Insiders Select Fund and the S&P STARS, Large
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Cap and Small Cap Portfolios each must invest at least 85% of its total assets
in equities: the Focus List and International Equity Portfolios must each invest
at least 90% and 65%, respectively, of its total assets in equities; and the
Balanced Portfolio must invest between 40% and 60% of its total assets in
equities. The Income, High Yield and EMD Portfolios each may invest 35%, 20% and
30%, respectively, of its total assets in equity securities, including
distressed securities, as described above. These securities include foreign and
domestic common stocks or preferred stocks, rights and warrants and debt
securities or preferred stock that are convertible or exchangeable for common
stock or preferred stock.
Investors in these Portfolios should be willing to accept the price
volatility associated with stocks in exchange for their relatively high return
potential compared to other asset classes.
Fixed Income Securities. The Money Market Portfolio may invest
-----------------------
without limit in short-term fixed income securities. The Income, High Yield and
EMD Portfolios each must invest at least 65%,
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80% and 70%, respectively, of its total assets in fixed income securities; and
the Balanced Portfolio must invest between 40% and 60% of its total assets in
fixed income securities. The Insiders Select Fund and the S&P STARS, Large Cap
and Small Cap Portfolios each may invest up to 15% of its total assets in fixed
income securities. The Focus List and International Equity Portfolios each may
invest up to 10% and 35%, respectively, of its total assets in fixed income
securities. Fixed-income securities include certain corporate debt obligations
and U.S. government securities. Although interest-bearing securities are
investments that promise a stable stream of income, the prices of such
securities typically are inversely affected by changes in interest rates and,
therefore, are subject to the risk of market price fluctuations. Thus, if
interest rates have increased from the time a security was purchased, such
security, if sold, might be sold at a price less than its cost. Similarly, if
interest rates have declined from the time a security was purchased, such
security, if sold, might be sold at a price greater than its cost. In either
instance, if the security was purchased at face value and held to maturity, no
gain or loss would be realized. Certain securities purchased by a Portfolio,
such as those with interest rates that fluctuate directly or indirectly based on
multiples of a stated index, are designed to be highly sensitive to changes in
interest rates and can subject the holders thereof to extreme reductions of
yield and possibly loss of principal.
Emerging Market Countries. The Income, High Yield, EMD, Balanced and
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International Equity Portfolios each may invest in the securities of issuers
located in countries that are considered to be emerging or developing ("emerging
countries") by the World Bank, the International Finance Corporation, or the
United Nations and its authorities. The Income Portfolio may invest up to 5% of
its total assets in these securities. A company is considered to be an emerging
country issuer if: (i) its securities are principally traded in an emerging
country; (ii) it derives at least 50% of its total revenue from (a) providing
goods or services in emerging countries or (b) sales made in emerging countries;
(iii) it maintains 50% or more of its assets in one or more emerging countries;
or (iv) it is organized under the laws of, or has a principal office in, an
emerging country.
Emerging Market Country Loans. The EMD Portfolio may invest in
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emerging market country loans. Dollar-denominated fixed and floating rate loans
may be arranged through private negotiations between one or more financial
institutions and an obligor in an emerging market country ("Emerging Country
Loans"). In connection with purchasing participations, an investor generally
will have no right to enforce compliance by the borrower with the terms of the
loan agreement, nor any rights of setoff against the borrower, and an investor
may not directly benefit from any collateral supporting the Emerging Country
Loan in which it has purchased the participation. As a result, an investor will
assume the credit risk of both the borrower and the lender that is selling the
participation. In the event of the insolvency of the lender selling a
participation, an investor may be treated as a general creditor of the lender
and may not benefit from any set-off between the lender and the borrower. The
EMD Portfolio will acquire participations only if the lender interpositioned
between the Portfolio and the borrower is determined by the Adviser to be
creditworthy. When the EMD Portfolio purchases assignments from lenders, the
Portfolio will acquire direct rights against the borrower of the Emerging
Country Loan. However, since assignments are arranged through private
negotiations between potential assignees and potential assignors, the rights and
obligations acquired by the EMD Portfolio as the purchaser of an assignment may
differ from, and be more limited than, those held by the assigning lender.
In addition, certain Emerging Country Loans may be or may become
subject to agreements to restructure the obligations. These agreements
occasionally require the owners of the obligations to contribute additional
capital. In such cases, an investor, as a participant, may be required to
contribute its pro-rata portion of the funds demanded even though it may have
insufficient assets to make such contribution. If this were to occur, the EMD
Portfolio could be forced to liquidate loan participations or sub-participations
at unfavorable prices to avoid the new money obligations.
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Emerging Market Securities. The Income, High Yield, EMD, Balanced and
--------------------------
International Equity Portfolios each may invest in emerging market securities.
The Income Portfolio may invest up to 5% of its total assets in these
securities. The securities markets of certain emerging market countries may be
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 early 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. In addition, 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 a 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, the securities of non-U.S. issuers
generally are not registered with the Securities and Exchange Commission (the
"SEC"), and issuers of these securities usually are not subject to its reporting
requirements. Accordingly, there may be less publicly available information
about foreign securities and issuers than is available with respect to U.S.
securities and issuers. Foreign companies generally are not subject to uniform
accounting, auditing and financial reporting standards, practices and
requirements comparable to those prevalent in the U.S.
Existing laws and regulations of emerging market countries may be
inconsistently applied. As legal systems in emerging market countries develop,
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. A Portfolio's ability to enforce its
rights against private emerging market country issuers by attaching assets to
enforce a judgment may be limited. Bankruptcy, moratorium and other similar
laws applicable to private emerging market country issuers may differ
substantially from those of other countries. The political context, expressed
as an emerging market governmental issuer's willingness to meet the terms of its
debt obligations, for example, is of considerable importance. In addition, the
holders of commercial bank debt may contest payments to the holders of emerging
market country debt securities in the event of default under commercial bank
loan agreements.
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 Portfolio. The 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
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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 a Portfolio may invest
and adversely affect the value of its assets.
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 certain 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 certain 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
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.
See "Taxes."
Foreign Government Securities. The Income, High Yield, EMD and
-----------------------------
International Equity Portfolios each may invest in foreign government securities
to the extent that these Portfolios may invest in fixed income securities, as
described in "Fixed Income Securities" above. Investment in sovereign debt
obligations involves special risks not present in debt obligations of U.S.
corporate issuers. The issuer of the debt or the governmental authorities that
control the repayment of the debt may be unable or unwilling to repay principal
or interest when due in accordance with the terms of such debt, and an investor
may have limited recourse in the event of a default. Periods of economic
uncertainty may result in volatile sovereign debt market prices. A sovereign
debtor's willingness or ability to repay principal and pay interest in a timely
manner may be affected by, among other factors, its cash flow situation, the
extent of its foreign currency reserves, the availability of sufficient foreign
exchange on the date a payment is due, the relative size of the debt service
burden to the economy as a whole, the sovereign debtor's policy toward
international lenders and the political constraints to which a sovereign debtor
may be subject. When an emerging country government defaults on its debt
obligations, the investor must pursue any remedies in the courts of the
defaulting party itself.
Certain emerging market governments that issue lower quality debt
securities are among the largest debtors to commercial banks, foreign
governments and supranational organizations such as the World Bank, and may be
unwilling or unable to make repayments as they become due. Below-investment-
grade debt securities are generally unsecured and may be subordinated to the
claims of other creditors, resulting in a heightened risk of loss due to
default.
Foreign Securities. Each Portfolio may invest in foreign securities.
------------------
The International Equity Portfolio must invest at least 65% (and may invest up
to 100%) of its total assets in foreign securities. The High Yield Portfolio may
invest up to 25% of its total assets in foreign securities, the Large Cap and
Small Cap Portfolios each may invest up to 10% of its total assets in these
securities and the Balanced Portfolio may invest up to 5% of its total assets in
these securities. Investing in foreign securities involves certain special
considerations, including those set forth below, which are not typically
associated with investing in U.S. dollar-denominated or quoted securities of
U.S. issuers. Investments in foreign securities usually involve currencies of
foreign countries. Accordingly, a Portfolio's investment in foreign securities
may be affected by changes in currency rates and in exchange control regulations
and
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costs incurred in converting among various currencies. A Portfolio may also be
subject to currency exposure as a result of its investment in currency or
currency futures.
Currency exchange rates may fluctuate significantly over short periods
of time. They generally are determined by the forces of supply and demand in the
foreign exchange markets and the relative merits of investments in different
countries, actual or anticipated changes in interest rates and other complex
factors, as seen from an international perspective. Currency exchange rates also
can be affected unpredictably by intervention by U.S. or foreign governments or
central banks or the failure to intervene or by currency controls or political
developments in the United States or abroad.
Since foreign issuers generally are not subject to uniform accounting,
auditing and financial reporting standards, practices and requirements
comparable to those applicable to U.S. companies, there may be less publicly
available information about a foreign company than about a U.S. company. Volume
and liquidity in most foreign securities markets are less than in the United
States and securities of many foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. Fixed commissions on
foreign securities exchanges are generally higher than negotiated commissions on
U.S. exchanges, although a Portfolio that invests in such securities endeavors
to achieve the most favorable net results on its portfolio transactions. There
is generally less government supervision and regulation of foreign securities
exchanges, brokers, dealers and listed and unlisted companies than in the United
States.
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 some of the Portfolio's assets are uninvested and no
return is earned on such assets. The inability of a Portfolio to make intended
security purchases due to settlement problems could cause the Portfolio to miss
attractive investment opportunities. Inability to dispose of portfolio
securities 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. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments which
could affect the Portfolio's investments in those countries. Moreover,
individual foreign economies may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
Investment in foreign companies, foreign branches of U.S. banks,
foreign banks, or other foreign issuers, may take the form of ownership of
securities issued by such entities or may take the form of sponsored and
unsponsored American Depositary Receipts ("ADRs"), Global Depositary Receipts
("GDRs"), European Depositary Receipts ("EDRs") or other similar instruments
representing securities of foreign issuers. An ADR is a negotiable receipt,
usually issued by a U.S. bank, that evidences ownership of a specified number of
foreign securities on deposit with a U.S. depository and entitles the
shareholder to all dividends and capital gains of the underlying securities.
ADRs are traded on U.S. exchanges or in the U.S. over-the-counter market and,
generally, are in registered form. EDRs and GDRs are receipts evidencing an
arrangement with a non-U.S. bank similar to that for ADRs and are designed for
use in the non-U.S. securities markets. EDRs and GDRs are not necessarily quoted
in the same currency as the underlying security.
In the case of sponsored ADRs, the issuer of the underlying foreign
security and the depositary enter into a deposit agreement, which sets out the
rights and responsibilities of the issuer, the depositary and the ADR holder.
Under the terms of most sponsored arrangements, depositaries agree to
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<PAGE>
distribute notices of shareholder meetings and voting instructions, thereby
ensuring that ADR holders will be able to exercise voting rights through the
depositary with respect to deposited securities. In addition, the depositary
usually agrees to provide shareholder communications and other information to
the ADR holder at the request of the issuer of the deposited securities. In the
case of an unsponsored ADR, there is no agreement between the depositary and the
issuer and the depositary is usually under no obligation to distribute
shareholder communications received from the issuer of the deposited securities
or to pass through voting rights to ADR holders in respect of deposited
securities. With regard to unsponsored ADRs, there may be an increased
possibility that the Portfolio would not become aware of or be able to respond
to corporate actions such as stock splits or rights offerings in a timely
manner. In addition, the lack of information may result in inefficiencies in the
valuation of such instruments.
Funding Agreements. Portfolios may invest in funding
------------------
agreements (sometimes referred to as Guaranteed Interest Contracts or "GICs") of
insurance companies. In such cases, the Portfolio contributes cash to a deposit
fund of the insurance company's general account, and the insurance company then
credits the Portfolio, on a monthly basis, guaranteed interest that is based on
an index. All funding agreements will provide that this guaranteed interest will
not be less than a certain minimum rate. Because the principal amount of a
funding agreement may not be received from the insurance company on seven days
notice or less, the agreement is considered to be an illiquid investment and,
together with other instruments in a Portfolio which are not readily marketable,
will not exceed, for the Money Market Portfolio, 10% of the Portfolio's net
assets and for all other Portfolios, 15% of the Portfolio's net assets. In
determining dollar-weighted average portfolio maturity, all funding agreements
will be deemed to have a maturity equal to the period of time remaining until
the next readjustment of the guaranteed interest rate.
Illiquid Securities. Each Portfolio, other than the Money Market
-------------------
Portfolio, may invest up to 15% of its net assets in illiquid securities. The
Money Market Portfolio may invest up to 10% of its assets in these securities.
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 that have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Limitations on resale may have an adverse effect on the
marketability of portfolio securities and an investor 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.
An investor might also seek to have such restricted securities registered 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. The Advisers anticipate that the market for
certain restricted securities will expand further as a result of this regulation
and the development of automated systems for the trading,
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<PAGE>
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. The Advisers will monitor the
liquidity of such restricted securities subject to the supervision of the Board.
In reaching liquidity decisions, the Advisers 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 NRSROs, or if only one NRSRO rates the
securities, by that NRSRO, or, if unrated, be of comparable quality in the view
of the Advisers; 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 SEC has taken the position that purchased over-the-counter ("OTC")
options and the assets used as "cover" for written OTC options are deemed
illiquid securities unless a Portfolio and the counterparty have provided for
the Portfolio, at the Portfolio's election, to unwind the OTC option. The
unwinding 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, thereby allowing the Portfolio to treat as liquid those
securities that were formerly used as "cover."
Inverse Floating Rate Securities. The Balanced Portfolio may invest
--------------------------------
up to 5% of its net assets in inverse floating rate securities. The interest
rate on leveraged inverse floating rate debt instruments ("inverse floaters")
resets in the opposite direction from the market rate of interest to which the
inverse floater is indexed . An inverse floater may be considered to be
leveraged to the extent that its interest rate varies by a magnitude that
exceeds the magnitude of the change in the index rate of interest. The higher
degree of leverage inherent in inverse floaters is associated with greater
volatility in their market values. Accordingly, the duration of an inverse
floater may exceed its stated final maturity. Certain inverse floaters may be
deemed to be illiquid securities for purposes of the Balanced Portfolio's 15%
limitation on investments in such securities.
Investment in Other Investment Companies. In accordance with the 1940
----------------------------------------
Act, each Portfolio may invest a maximum of up to 10% of the value of its total
assets in securities of other investment companies, and each Portfolio may own
up to 3% of the total outstanding voting stock of any one investment company. In
addition, up to 5% of the value of each Portfolio's total assets may be invested
in the securities of any one investment company.
Money Market Instruments. Each Portfolio may invest in money market
------------------------
instruments. The S&P STARS, Large Cap and Small Cap Portfolios each may invest
15% of its total assets in these instruments. The Balanced and International
Equity Portfolios each may invest 20% and 35%, respectively, of its total assets
in these instruments.
A Portfolio may invest in money market instruments, including U.S.
government obligations, U.S. Treasury bills and commercial paper that is (a)
rated at the time of purchase in the highest category by an NRSRO; (b) issued by
a company having an outstanding unsecured debt issue currently rated not lower
than "Aa3" by Moody's or "AA" by S&P or Fitch IBCA, Duff & Phelps ("Fitch"); or
(c) if unrated, of comparable quality. A Portfolio may also invest in bank
obligations,
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including, without limitation, time deposits, bankers' acceptances and
certificates of deposit, which may be general obligations of the parent bank or
may be limited to the issuing branch by the terms of the specific obligations or
by government regulation. Banks are subject to extensive governmental
regulations, which may limit both the amount and types of loans which may be
made and interest rates which may be charged. In addition the profitability of
the banking industry is largely dependent upon the availability and cost of
funds for the purpose of financing lending operations under prevailing money
market conditions. General economic conditions as well as exposure to credit
losses arising from possible financial difficulties of borrowers play an
important part in the operation of this industry.
Mortgage-Related Securities. The Money Market, Income, High Yield,
---------------------------
EMD, Balanced and International Equity Portfolios each may invest in mortgage-
related securities. The Balanced Portfolio may invest up to 25% of its total
assets in these securities. Mortgage-related securities are backed by mortgage
obligations including, among others, conventional 30-year fixed rate mortgage
obligations, graduated payment mortgage obligations, 15-year mortgage
obligations, and adjustable-rate mortgage obligations. All of these mortgage
obligations can be used to create pass-through securities. A pass-through
security is created when mortgage obligations are pooled together and undivided
interests in the pool or pools are sold. The cash flow from the mortgage
obligations is passed through to the holders of the securities in the form of
periodic payments of interest, principal and prepayments of principal (net of a
service fee). Prepayments occur when the holder of an individual mortgage
obligation prepays the remaining principal before the mortgage obligation's
scheduled maturity date. As a result of the pass-through of prepayments of
principal on the underlying securities, mortgage-related securities are often
subject to more rapid prepayment of principal than their stated maturity
indicates. Because the prepayment characteristics of the underlying mortgage
obligations vary, it is not possible to predict accurately the realized yield or
average life of a particular issue of pass-through certificates. Prepayment
rates are important because of their effect on the yield and price of the
securities. Accelerated prepayments have an adverse impact on yields for pass-
throughs purchased at a premium (i.e., a price in excess of principal amount)
and may involve additional risk of loss of principal because the premium may not
have been fully amortized at the time the obligation is repaid. The opposite is
true for pass-throughs purchased at a discount. A Portfolio may purchase
mortgage-related securities at a premium or at a discount.
The Income Portfolio may invest in stripped mortgage-related
securities that are created by segregating the cash flows from underlying
mortgage loans or mortgage securities to create two or more new securities.
Each has a specified percentage of the underlying security's principal or
interest payments. Mortgage securities may be partially stripped, so that each
class receives some interest and some principal, or they may be completely
stripped. In that case, all of the interest is distributed to holders of an
"interest-only" security, and all of the principal is distributed to holders of
a "principal-only" security. Strips can be created for pass-through
certificates or collateralized mortgage obligations ("CMOs"). The yields to
maturity of interest-only and principal-only stripped mortgage-related
securities are very sensitive to principal repayments on the underlying
mortgages.
U.S. Government Agency Securities. Mortgage-related securities issued
by the Government National Mortgage Association ("GNMA") include GNMA Mortgage
Pass-Through Certificates (also known as "Ginnie Maes"). Ginnie Maes are
guaranteed as to the timely payment of principal and interest by GNMA and are
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. Mortgage-related securities
issued by the Federal National Mortgage Association ("FNMA") include FNMA
Guaranteed Mortgage Pass-Through
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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. 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"). FHLMC is a corporate instrumentality of the United
States created pursuant to an Act of Congress, which is owned entirely by the
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. FHLMC
guarantees either ultimate collection or timely payment of all principal
payments on the underlying mortgage loans. When FHLMC does not guarantee timely
payment of principal, FHLMC may remit the amount due on account of its guarantee
of ultimate payment of principal at any time after default on an underlying
mortgage, but in no event later than one year after it becomes payable.
Mortgage Dollar Rolls. The Money Market, Income, High Yield, EMD,
---------------------
Balanced and International Equity Portfolios each may invest in mortgage "dollar
rolls," which involve the sale of securities for delivery in the current month
and a simultaneous contract with the counterparty to repurchase substantially
similar (same type, coupon and maturity) but not identical securities on a
specified future date. The Balanced Portfolio may invest up to 25% of its total
assets in these securities. During the roll period, the seller loses the right
to receive principal and interest paid on the securities sold. An investor
would benefit, however, to the extent of any difference between the price
received for the securities sold and the lower forward price for the future
purchase or fee income plus the interest earned on the cash proceeds of the
securities sold until the settlement date for the forward purchase. The use of
this technique will diminish investment performance unless such benefits exceed
the income, capital appreciation and gain or loss due to mortgage prepayments
that would have been realized on the securities sold as part of the mortgage
dollar roll. The Balanced Portfolio will hold and maintain in a segregated
account until the settlement date cash or liquid securities in an amount equal
to the forward purchase price. Successful use of mortgage dollar rolls depends
on the Adviser's ability to predict correctly interest rates and mortgage
prepayments. For financial reporting and tax purposes, the Balanced Portfolio
treats mortgage dollar rolls as two separate transactions: one involving the
purchase of a security and a separate transaction involving a sale. The
Balanced Portfolio currently does not intend to enter into mortgage dollar rolls
that are accounted for as a financing.
Municipal Obligations. The Income and High Yield Portfolios each may
---------------------
invest up to 25% and 5% of total assets, respectively, in municipal obligations.
The Balanced Portfolio may invest up to 5% of its net assets in these
securities. 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
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from the related municipal obligation and purchased and sold separately. The
Portfolios may invest in municipal obligations, the ratings of which correspond
with the ratings of other permissible investments.
Real Estate Investment Trusts ("REITs"). The Balanced Portfolio may
---------------------------------------
invest up to 10% of its total assets in REITs, which are pooled investment
vehicles which invest primarily in income producing real estate or real estate
related loans or interest. REITs are generally classified as equity REITs,
mortgage REITs or a combination of equity and mortgage REITs. Equity REITs
invest the majority of their assets directly in real property and derive income
primarily from the collection of rents. Equity REITs can also realize capital
gains by selling properties that have appreciated in value. Mortgage REITs
invest the majority of their assets in real estate mortgages and derive income
from the collection of interest payments. Like regulated investment companies
such as the Portfolio, REITs are not taxed on income distributed to shareholders
provided they comply with certain requirements under the Internal Revenue Code
of 1986, as amended (the "Code"). A Portfolio will indirectly bear its
proportionate share of any expenses incurred by REITs in which it invests in
addition to the expenses paid by the Portfolio.
Investing in REITs involves certain unique risks. Equity REITs may be
affected by changes in the value of the underlying property owned by such REITs,
while mortgage REITs may be affected by the quality of any credit extended.
REITs are dependent upon management skills, are not diversified (except to the
extent the Code requires), and are subject to the risks of financing projects.
REITs are subject to heavy cash flow dependency, default by borrowers, self-
liquidation, and the possibilities of failing to qualify for the exemption from
tax for distributed income under the Code and failing to maintain their
exemptions from the 1940 Act. REITs (especially mortgage REITs) are also
subject to interest rate risks.
Repurchase Agreements. Each Portfolio may enter into repurchase
---------------------
agreements. The Balanced Portfolio may invest up to 20% of its total assets in
repurchase agreements. Repurchase agreements are a type of secured lending and
typically involve the acquisition of debt securities from a financial
institution, such as a bank, savings and loan association or broker-dealer,
which then agrees to repurchase the security at a specified resale price on an
agreed future date (ordinarily one week or less). The difference between the
purchase and resale prices generally reflects the market interest rate for the
term of the agreement.
A Portfolio's custodian or sub-custodian will have custody of, and
will hold in a segregated account, securities that the Portfolio acquires under
a repurchase agreement. Repurchase agreements are considered by the SEC to be
loans. If the seller defaults, a Portfolio might suffer a loss to the extent
the proceeds from the sale of the securities underlying the repurchase agreement
are less than the repurchase price. In an attempt to reduce the risk of
incurring a loss on a repurchase agreement, a Portfolio will enter into
repurchase agreements only with counterparties whose short-term paper is rated
no lower than "A1/P1" or whose corporate parent has a rating of no lower than
"A1/P1" 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. The Adviser will
monitor on an ongoing basis the value of the collateral to assure that it always
equals or exceeds the repurchase price. A Portfolio will consider on an ongoing
basis the creditworthiness of the institutions with which it enters into
repurchase agreements.
Reverse Repurchase Agreements. The High Yield and EMD Portfolios each
-----------------------------
may borrow by entering into reverse repurchase agreements, pursuant to which, it
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
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account with the custodian. A reverse repurchase agreement involves the risk
that the market value of the portfolio securities sold by a Portfolio may
decline below the price of the securities it must repurchase, which price is
fixed at the time the Portfolio enters into such agreement.
Standby Commitment Agreements. The EMD Portfolio may invest in
-----------------------------
standby commitment agreements, which commit an investor, for a stated period of
time, to purchase a stated amount of a fixed income security which may be issued
and sold to the investor at the option of the issuer. The price and coupon of
the security are fixed at the time of the commitment. At the time of entering
into the agreement an investor receives a commitment fee, regardless of whether
the security is ultimately issued, which is typically approximately 0.50% of the
aggregate purchase price of the security that the investor has committed to
purchase. The EMD Portfolio will enter into such agreements only for the purpose
of investing in the security underlying the commitment at a yield and price that
is considered advantageous. The EMD Portfolio will not enter into a standby
commitment with a remaining term in excess of 45 days and will limit its
investment in such commitments so that the aggregate purchase price of the
securities subject to such commitments, together with the value of portfolio
securities subject to legal restriction on resale, will not exceed 10% of its
assets determined at the time of the acquisition of such commitment or security.
The EMD Portfolio will at all times maintain a segregated account with its
custodian of cash or liquid securities in U.S. dollars or non-U.S. currencies in
an aggregate amount equal to the purchase price of the securities underlying the
commitment.
Securities subject to a standby commitment may not be issued and the
value of a security, if issued, on the delivery date may be more or less than
its purchase price. Because the issuance of the security underlying the
commitment is at the option of the issuer, the EMD Portfolio may bear the risk
of a decline in the value of such security and may not benefit from an
appreciation in the value of the security during the commitment period.
The purchase of a security subject to a standby commitment agreement
and the related commitment fee will be recorded on the date on which the
security can reasonably be expected to be issued, and the value of the security
will be adjusted by the amount of the commitment fee. In the event the security
is not issued, any commitment fee previously paid and expensed will be recorded
as income on the expiration date of the standby commitment.
Structured Securities. Each Portfolio, other than the Money Market
---------------------
Portfolio, may invest in structured or indexed securities. The Balanced
Portfolio may invest up to 5% of its total assets in these securities.
Structured securities (sometimes referred to as hybrid securities or indexed
securities) are considered derivative instruments. The value of the principal
of and/or interest on structured securities is linked to, or determined by,
reference to changes in the value of specific currencies, interest rates,
commodities, indices or other financial indicators (the "Reference") or the
relative change in two or more References. The interest rate or the principal
amount payable upon maturity or redemption may be increased or decreased
depending upon changes in the applicable Reference. The terms of the structured
securities may provide that in certain circumstances no principal is due at
maturity and, therefore, result in the loss of a Portfolio's investment.
Structured securities may be positively or negatively indexed, so that
appreciation of the Reference may produce an increase or decrease in the
interest rate or value of the security at maturity. In addition, changes in the
interest rates or the value of the security at maturity may be a multiple of
changes in the value of the Reference. Consequently, structured securities may
entail a greater degree of market risk than other types of fixed-income
securities. Structured securities may also be more volatile, less liquid and
more difficult to accurately price than less complex securities.
Trade Claims. The High Yield and EMD Portfolios each may invest in
------------
trade claims. Trade claims 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
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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 debtor, (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 a 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 a 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 substantial
legal expenses to a 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 Code.
Variable and Floating Rate Securities. Each Portfolio may invest in
-------------------------------------
variable and floating rate securities. The interest rates payable on certain
fixed-income securities in which a Portfolio may invest are not fixed and may
fluctuate based upon changes in market rates. A variable rate obligation is one
whose terms provide for the readjustment of its interest rate on set dates and
which, upon such readjustment, reasonably can be expected to have a market value
that approximates its par value. A floating rate obligation is one whose terms
provide for the readjustment of its interest rate whenever a specified interest
rate changes and which, at any time, reasonably can be expected to have a market
value that approximates its par value. Variable and floating rate obligations
provide holders with protection against rises in interest rates, but pay lower
yields than fixed rate obligations of the same maturity. Variable rate
obligations may fluctuate in value in response to interest rate changes if there
is a delay between changes in market interest rates and the interest reset date
for the obligation.
Warrants and Stock Purchase Rights. The EMD Portfolio may invest in
----------------------------------
warrants and stock purchase rights. The Insiders Select Fund and the S&P STARS,
Large Cap, Small Cap, Balanced and International Equity Portfolios each may
invest up to 5% of its total assets in these instruments. Warrants or rights
(other than those acquired in units or attached to other securities) entitle the
holder to buy equity securities at a specific price for a specific period of
time. Warrants and rights have no voting rights, receive no dividends and have
no rights with respect to the assets of the issuer.
When-Issued and Forward Commitments. Each Portfolio, other than the
-----------------------------------
Money Market, EMD and International Equity Portfolios, may invest up to 33-1/3%
of its total assets in when-issued or forward commitment transactions. The
Money Market and International Equity Portfolios each may invest up to 25% and
20% of its total assets, respectively, in these transactions. The EMD Portfolio
may invest up to 15% of its assets in when, as and if issued securities.
A Portfolio may purchase securities on a when-issued basis or purchase
or sell securities on a forward commitment basis. These transactions involve a
commitment by the Portfolio to purchase or sell securities at a future date.
The price of the underlying securities (usually expressed in terms of yield) and
the date when the securities will be delivered and paid for (the settlement
date) are fixed at the time the transaction is negotiated. When-issued
purchases and forward commitment transactions are negotiated directly with the
other party, and such commitments are not traded on exchanges. A Portfolio will
purchase securities on a when-issued basis or purchase or sell securities on a
forward commitment basis only with the intention of completing the transaction
and actually purchasing or selling the securities. If deemed advisable as a
matter of investment strategy, however, a Portfolio may dispose of or negotiate
a commitment after entering into it. A Portfolio may realize a capital gain or
loss in connection
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with these transactions. For purposes of determining a Portfolio's duration, the
maturity of when-issued or forward commitment securities will be calculated from
the commitment date. A Portfolio is required to hold and maintain in a
segregated account with the Portfolio's custodian until three days prior to the
settlement date, cash and liquid securities in an amount sufficient to meet the
purchase price. Alternatively, the Portfolio may enter into offsetting contracts
for the forward sale of other securities that it owns. Securities purchased or
sold on a when-issued or forward commitment basis involve a risk of loss if the
value of the security to be purchased declines prior to the settlement date or
if the value of the security to be sold increases prior to the settlement date.
The issuance of certain securities depends upon the occurrence of a
subsequent event, such as approval of a merger, corporate reorganization,
leveraged buyout or debt restructuring ("when, as and if issued securities"). As
a result, the period from the trade date to the issuance date may be
considerably longer than a typical when-issued trade. Each when-issued
transaction specifies a date upon which the commitment to enter into the
relevant transaction will terminate if the securities have not been issued on or
before such date. In some cases, however, the securities may be issued prior to
such termination date, but may not be deliverable until a period of time
thereafter. If the anticipated event does not occur and the securities are not
issued, a Portfolio would be entitled to retain any funds committed for the
purchase, but the Portfolio may have foregone investment opportunities during
the term of the commitment.
Zero Coupon, Pay-In-Kind Or Deferred Payment Securities. Each
-------------------------------------------------------
Portfolio may invest in zero coupon securities and each Portfolio, other than
the International Equity Portfolio, may invest in pay-in-kind and other discount
securities. Zero coupon securities are securities that are sold at a discount
to par value and on which interest payments are not made 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 "accreted 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
zero coupon securities 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 comparably rated securities paying cash interest
at regular intervals. In addition, because a Portfolio must distribute income
to its shareholders to qualify for pass-through federal tax treatment (including
"accreted income" or the value of the pay-in-kind interest), it may have to
dispose of its investments under disadvantageous circumstances to generate the
cash, or may have to borrow to implement these distributions.
Management Policies
Below Investment Grade and Unrated Securities. Debt securities that
---------------------------------------------
are unrated or below investment grade are generally considered to have a credit
quality rated below investment grade by NRSROs such as Moody's and S&P.
Securities rated below investment grade are the equivalent of high yield, high
risk bonds, commonly known as "junk bonds." Investment grade debt is generally
rated "BBB" or higher by S&P or "Baa" or higher by Moody's. Below investment-
grade debt securities (that is, securities rated "Ba1" or lower by Moody's or
"BB+" or lower by S&P) are regarded as predominantly speculative with respect to
the issuer's capacity to pay interest and repay principal in accordance with the
terms of the obligations and involve major risk exposure to adverse conditions.
Some of the debt securities held by a Portfolio may be comparable to securities
rated as low as "C" by Moody's or "D" by
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S&P, the lowest ratings assigned by these agencies. These securities are
considered to have extremely poor prospects of ever attaining any real
investment grade standing, and to have a current identifiable vulnerability to
default, and the issuers and/or guarantors of these securities are considered to
be unlikely to have the capacity to pay interest and repay principal when due in
the event of adverse business, financial or economic conditions and/or to be in
default or not current in the payment of interest or principal.
Below investment-grade and unrated debt securities generally offer a
higher current yield than that available from investment grade issues, but
involve greater risk. Below investment-grade and unrated securities are
especially subject to adverse changes in general economic conditions, to changes
in the financial condition of their issuers and to price fluctuation in response
to changes in interest rates. During periods of economic downturn or rising
interest rates, issuers of below-investment-grade and unrated instruments may
experience financial stress that could adversely affect their ability to make
payments of principal and interest, to meet projected business goals and to
obtain additional financing. If the issuer of a bond defaults, a Portfolio may
incur additional expenses to seek recovery. A foreign issuer may not be willing
or able to repay the principal or interest of such obligations when it becomes
due, due to factors such as debt service, cash flow situation, the extent of its
foreign reserves, and the availability of sufficient foreign exchange on the
date a payment is due. The risk of loss due to default by the issuer is
significantly greater for the holders of below-investment-grade and unrated debt
securities because such securities may be unsecured and may be subordinated to
other creditors of the issuer. In addition, in recent years some Latin American
countries have defaulted on their sovereign debt.
A Portfolio may have difficulty disposing of certain high yield, high
risk securities because there may be a thin trading market for such securities.
The secondary trading market for high yield, high risk securities is generally
not as liquid as the secondary market for higher rated securities. Reduced
secondary market liquidity may have an adverse impact on market price and a
Portfolio's ability to dispose of particular issues when necessary to meet
liquidity needs or in response to a specific economic event such as a
deterioration in the creditworthiness of the issuer.
Below investment-grade and unrated debt securities frequently have
call or redemption features which would permit an issuer to repurchase the
security from a Portfolio. If a call were exercised by the issuer during a
period of declining interest rates, the Portfolio likely would have to replace
such called security with a lower yielding security, thus decreasing the net
investment income to the Portfolio and dividends to shareholders.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may also decrease the values and liquidity of below
investment-grade and unrated securities especially in a market characterized by
low trading volume. Factors adversely affecting the market value of high yield,
high risk securities are likely to adversely affect a Portfolio's net asset
value ("NAV"). In addition, a Portfolio may incur additional expenses to the
extent it is required to seek recovery upon a default on a portfolio holding or
participate in the restructuring of an obligation.
An economic downturn could severely affect the ability of highly
leveraged issuers of below investment-grade securities to service their debt
obligations or to repay their obligations upon maturity. Factors having an
adverse impact on the market value of below-investment-grade bonds will have an
adverse effect on a Portfolio's NAV to the extent it invests in such securities.
In addition, the Portfolio may incur additional expenses to the extent it is
required to seek recovery upon a default in payment of principal or interest on
its portfolio holdings.
The secondary market for below investment-grade bonds, which is
concentrated in relatively few market makers, may not be as liquid as the
secondary market for investment grade
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securities. This reduced liquidity may have an adverse effect on the ability of
the Portfolio to dispose of a particular security when necessary to meet its
redemption requests or other liquidity needs. Under adverse market or economic
conditions, the secondary market for below investment-grade bonds could contract
further, independent of any specific adverse changes in the condition of a
particular issuer. As a result, the Advisers could find it difficult to sell
these securities or may be able to sell the securities only at prices lower than
if such securities were widely traded. Prices realized upon the sale of
below-investment-grade or comparable unrated securities, under such
circumstances, may be less than the prices used in calculating the Portfolio's
NAV.
Since investors generally perceive that there are greater risks
associated with the medium-rated and below investment-grade securities, the
yields and prices of such securities may tend to fluctuate more than those for
highly rated securities because changes in the perception of these issuers'
creditworthiness tend to occur more frequently and in a more pronounced manner
than do changes in higher quality segments of the fixed-income securities
market, resulting in greater yield and price volatility.
Another factor which causes fluctuations in the prices of fixed-income
securities is the supply and demand for similarly rated securities. In
addition, the prices of fixed-income securities fluctuate in response to the
general level of interest rates. Fluctuations in the prices of portfolio
securities subsequent to their acquisition will not affect cash income from such
securities but will be reflected in the Portfolio's NAV.
Medium rated, below investment-grade and comparable unrated securities
tend to offer higher yields than higher rated securities with the same
maturities because the historical financial condition of the issuers of such
securities may not have been as strong as that of other issuers. Since these
securities generally involve greater risks of loss of income and principal than
higher rated securities, investors should consider carefully the relative risks
associated with investment in securities which carry medium to lower ratings and
in comparable unrated securities. In addition to the risk of default, there are
the related costs of recovery on defaulted issues. A Portfolio may attempt to
reduce these risks through portfolio diversification and by analysis of each
issuer and its ability to make timely payments of income and principal, as well
as broad economic trends and corporate developments.
Downgraded Debt Securities. Subsequent to its purchase by a
--------------------------
Portfolio, a debt issue may cease to be rated or its rating may be reduced below
the minimum required for purchase. Neither event will require the sale of such
securities by a Portfolio, but the Advisers will consider such event in
determining whether the Portfolio should continue to hold the securities. To
the extent that the ratings given by Moody's, S&P or Fitch may change as a
result of changes in such organizations or their rating systems, a Portfolio
will attempt to use comparable ratings as standards for its investments in
accordance with the investment policies contained in the Prospectus and this
SAI.
Options, in General. Each Portfolio (other than the Money Market
-------------------
Portfolio) may, but is not required to, use derivatives to reduce risk or
enhance return, including options on securities and financial indices. A
Portfolio may invest up to 5% of its total assets, represented by the premium
paid, in the purchase of put and call options. A Portfolio may write covered
put or call option contracts in an amount up to 20% of its net assets at the
time such option contracts are written.
Options on Securities. 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"),
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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 to the purchaser against receipt of the
exercise price. When a Portfolio writes a call option, it 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.
A Portfolio may purchase call options on securities in order to fix
the cost of a future purchase. A Portfolio also may purchase call options as a
means of enhancing returns by, for example, participating in an anticipated
price increase of a security on a more limited risk basis than would be possible
if the security itself were purchased. In the event of a decline in the price
of the underlying security, use of this strategy would serve to limit a
Portfolio's potential loss to the option premium paid; conversely, if the market
price of the underlying security increases above the exercise price and the
Portfolio either sells or exercises the option, any profit eventually realized
will be reduced by the premium paid.
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, a 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.
A Portfolio may purchase put options on securities in order to attempt
to hedge against a decline in the market value of securities it holds. A put
option would enable a Portfolio to sell the underlying security at a
predetermined exercise price; thus the potential for loss to the Portfolio below
the exercise price would be limited to the option premium paid. If the market
price of the underlying security were higher than the exercise price of the put
option, any profit a Portfolio realizes on the sale of the security would be
reduced by the premium paid for the put option less any amount for which the put
option may be sold.
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.
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. The Portfolio may therefore purchase
a put option on other carefully selected securities, the values of which the
Advisers expect will have a high degree of positive correlation to the values of
such portfolio securities. If the Advisers' 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 the Advisers' judgment is not correct,
the value of the securities underlying the put option may decrease less than the
value of the 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. The Portfolio may, therefore, purchase call
options on other carefully selected securities the values of which the Advisers
expect will have a high degree of positive correlation to the values of the
securities that the
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<PAGE>
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 acquired.
A Portfolio may write options on securities in connection with buy-
and-write transactions; that is, it 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 security's purchase
price 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.
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, a
Portfolio's maximum gain will be the premium received by it for writing the
option, adjusted upwards or downwards by the difference between the security's
purchase price 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.
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 the 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, the Portfolio may not be able to liquidate an
OTC option at a favorable price at any time
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prior to expiration. Until a Portfolio is able to effect a closing purchase
transaction in a covered OTC call option, 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."
OTC options purchased by a Portfolio will be treated as illiquid
securities subject to any applicable limitation on such securities. Similarly,
the assets used to "cover" OTC options written by a 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."
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 or
other liquid securities, marked-to-market daily, having a value equal to or
greater than the exercise price of the option.
Options on Securities Indices. A Portfolio also may purchase and
-----------------------------
write call and put options on securities indices in an attempt to hedge against
market conditions affecting the value of securities that the Portfolio owns or
intends to purchase. Through the writing or purchase of index options, a
Portfolio can achieve many of the same objectives as through the use of options
on individual securities. Options on securities indices are similar to options
on a security except that, rather than the right to take or make delivery of a
security at a specified price, an option on a securities index gives the holder
the right to receive, upon exercise of the option, an amount of cash if the
closing level of the securities index upon which the option is based is greater
than, in the case of a call, or less than, in the case of a put, the exercise
price of the option. This amount of cash is equal to such difference between
the closing price of the index and the exercise price of the option. The writer
of the option is obligated, in return for the premium received, to make delivery
of this amount. Unlike security options, all settlements are in cash and gain
or loss depends upon price movements in the market generally (or in a particular
industry or segment of the market), rather than upon price movements in
individual securities. Price movements in securities will probably not
correlate perfectly with movements in the level of an index and, therefore, the
Portfolio bears the risk that a loss on an index option would not be completely
offset by movements in the price of such securities.
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.
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 the Portfolio may expire worthless, in which case the
Portfolio would lose the premium paid therefor.
Options Straddles. A Portfolio may purchase and write covered
-----------------
straddles on securities or bond indices. A long straddle is a combination of a
call and a put option purchased on the same security where the exercise price of
the put is less than or equal to the exercise price of the call. A Portfolio
would
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<PAGE>
enter into a long straddle when the Adviser believes that it is likely that the
price of the underlying security will be more volatile during the term of the
options than the option pricing implies. A short straddle is a combination of a
call and a put written on the same security where the exercise price of the put
is less than or equal to the exercise price of the call and where the same issue
of security or currency is considered cover for both the put and the call. A
Portfolio would enter into a short straddle when the Adviser believes that it is
unlikely that the price of the underlying security will be as volatile during
the term of the options as the option pricing implies. In the case of a straddle
written by a Portfolio, the amount maintained in the segregated account will
equal the amount, if any, by which the put is "in-the-money."
Special Characteristics and Risks of Options Trading. A Portfolio may
----------------------------------------------------
effectively terminate its right or obligation under an option by entering into a
closing transaction. If a Portfolio wishes to terminate its obligation to
purchase or sell securities under a put or call option it has written, it may
purchase a put or call option of the same series (i.e., an option identical in
its terms to the option previously written); this is known as a closing purchase
transaction. Conversely, in order to terminate its right to purchase or sell
specified securities or currencies under a call or put option it has purchased,
a Portfolio may write an option of the same series as the option held; this is
known as a closing sale transaction. Closing transactions essentially permit a
Portfolio to realize profits or limit losses on its options positions prior to
the exercise or expiration of the option. Whether a profit or loss is realized
from a closing transaction depends on the price movement of the underlying
security or currency and the market value of the option.
The following considerations are important in deciding whether to use
options to enhance income or to hedge a Portfolio's investments:
(1) The value of an option position will reflect, among other things,
the current market price of the underlying security, or bond index, the time
remaining until expiration, the relationship of the exercise price to the market
price, the historical price volatility of the underlying security, or bond index
and general market conditions. For this reason, the successful use of options
as a hedging strategy depends upon the Adviser's ability to forecast the
direction of price fluctuations in the underlying securities or, in the case of
bond index options, fluctuations in the market sector represented by the
selected index.
(2) Exchange-traded options normally have expiration dates of up to 90
days and OTC options normally have expiration dates up to one year. The
exercise price of the options may be below, equal to or above the current market
value of the underlying securities, bond index or currencies. Purchased options
that expire unexercised have no value. Unless an option purchased by a
Portfolio is exercised or unless a closing transaction is effected with respect
to that position, the Portfolio will realize a loss in the amount of the premium
paid and any transaction costs.
(3) A position in an exchange-listed option may be closed out only on
an exchange that provides a secondary market for identical options. Although a
Portfolio intends to purchase or write only those options for which there
appears to be an active secondary market, a liquid secondary market may not
exist for any particular option at any specific time because of: (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.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
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<PAGE>
the O.C.C. as a result of trades on that exchange would generally continue to be
exercisable in accordance with their terms.
Closing transactions may be effected with respect to options traded in
the OTC markets (currently the primary markets for options on debt securities)
only by negotiating directly with the other party to the option contract, or in
a secondary market for the option if such a market exists. Although a Portfolio
will enter into OTC options only with dealers that are expected to be capable of
entering into closing transactions with the Portfolio, the Portfolio may not be
able to liquidate an OTC option at a favorable price at any time prior to
expiration.
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. In the
event of insolvency of the counter-party, the Portfolio may be unable to
liquidate an OTC option. Accordingly, it may not be possible to effect closing
transactions with respect to certain options, with the result that a Portfolio
would have to exercise those options which it has purchased in order to realize
any profit. Transactions are entered into by a Portfolio only with brokers or
financial institutions that the Adviser deems to be creditworthy.
With respect to options written by a Portfolio, the inability to enter
into a closing transaction may result in material losses to the Portfolio. For
example, because a Portfolio must maintain a covered position with respect to
any call option it writes on a security, securities index or currency, the
Portfolio may not sell the underlying security or currency (or invest any cash,
or liquid securities used to cover a securities index option) during the period
it is obligated under the option. This requirement may impair the Portfolio's
ability to sell the underlying security or make an investment at a time when
such a sale or investment might be advantageous.
(4) Securities index options are settled exclusively in cash. If a
Portfolio writes a call option on an index, the Portfolio will not know in
advance the difference, if any, between the closing value of the index on the
exercise date and the exercise price of the call option itself and thus will not
know the amount of cash payable upon settlement. In addition, a holder of a
securities index option who exercises it before the closing index value for that
day is available runs the risk that the level of the underlying index may
subsequently change.
(5) A Portfolio's activities in the options markets may result in
higher portfolio turnover rates and additional brokerage costs; however, the
Portfolio may also save on commissions by using options as a hedge rather than
buying or selling individual securities in anticipation or as a result of market
movements.
(6) 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. 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 those described in the Prospectus under "Risk Factors -- Foreign
Securities," including government actions affecting currency valuation and the
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
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<PAGE>
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, in General. Each Portfolio (other than the Money
-----------------------------
Market Portfolio) may, but is not required to, use derivatives to reduce risk or
enhance return, including futures contracts on securities and indices and
related options.
Futures Contracts and Related Options. A Portfolio may enter into
-------------------------------------
futures contracts for the purchase or sale of securities and financial indices
and currencies in accordance with the Portfolio's investment objective. 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. At the time a futures contract is purchased or sold, the Portfolio is
required to deposit cash or securities with a futures commission merchant or in
a segregated custodial account representing between approximately 10% to 5% of
the contract amount, called "initial margin." Thereafter, the futures contract
will be valued daily and the payment in cash of "maintenance" or "variation
margin" may be required, resulting in a Portfolio paying or receiving cash that
reflects any decline or increase in the contract's value, a process known as
"marking-to-market."
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."
A Portfolio's ability to establish and close out positions in futures
contracts and options on futures contracts would be affected 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, a liquid market on an exchange may not 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 the Portfolio
maintains a position, it would not be possible to 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 a Portfolio had written and which it was unable to close, it
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 the Advisers' 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 a 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
27
<PAGE>
or segregate securities with the required value, as described in "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 futures contracts and options
thereon when the Advisers' expectations are not met, assuming proper adherence
to the segregation requirement, the volatility of the investment 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 a 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, 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, a liquid market may not 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.
Limitations on the Purchase and Sale of Futures Contracts and Related
---------------------------------------------------------------------
Options.
--------
CFTC Limits. In accordance with Commodity Futures Trading Commission
("CFTC") regulations, a Portfolio is 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
existing futures and premiums paid for options on futures exceed 5% of the
liquidation value of the 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, the SEC requires it 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 and liquid securities 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 the Portfolio, may
require segregation of its 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
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<PAGE>
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.
Securities, currencies or other options or futures positions used for
cover and securities held in a segregated account cannot be sold or closed out
while the option or futures strategy is outstanding, unless they are replaced
with similar assets. As a result, there is a possibility that the use of cover
or segregation involving a large percentage of a Portfolio's assets could impede
fund management or the Portfolio's ability to meet current obligations.
Uses of Futures Contracts. Futures contracts will be used for bona
-------------------------
fide hedging, risk management and return enhancement purposes.
Position Hedging. A Portfolio might sell futures contracts to protect
against a decrease in the market value of its securities. This would be
considered a bona fide hedge and, therefore, is not subject to the 5% CFTC
limit. For example, if market values are expected to decline, a Portfolio might
sell futures contracts on securities, the values of which historically have
correlated closely or are expected to correlate closely to the values of its
portfolio securities. Such a sale would have an effect similar to selling an
equivalent value of portfolio securities. If market values decrease, the value
of a Portfolio's securities will decline, but the value of the futures contracts
will increase at approximately an equivalent rate, thereby keeping the
Portfolio's NAV from declining as much as it otherwise would have. In the case
of debt securities, a Portfolio could accomplish similar results by selling
securities with longer maturities and investing in securities with shorter
maturities. 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 market values rise rather than fall, the value of the
futures contract will fall but the value of the securities should rise and
should offset all or part of the loss. If futures contracts are used to hedge
100% of the securities position and correlate precisely with the securities
position, there should be no loss or gain with a rise (or fall) in market
values. However, if only 50% of the securities position is hedged with futures,
then the value of the remaining 50% of the securities position would be subject
to change because of market fluctuations. Whether securities positions and
futures contracts correlate precisely is a significant risk factor.
Anticipatory Position Hedging. When a Portfolio expects that market
values may decline and it intends to acquire securities, a Portfolio might
purchase futures contracts. The purchase of futures contracts for this purpose
would constitute an anticipatory hedge against increases in the price of the
securities which a 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
securities that would be purchased, a Portfolio could take advantage of the
anticipated rise in the cost of the securities without actually buying them.
The Portfolio could therefore make the intended purchases of the securities in
the cash market and concurrently liquidate the futures positions.
Risk Management and Return Enhancement -- Debt Securities. 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
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<PAGE>
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.
A Portfolio may use interest rate futures contracts to hedge its fund
against changes in the general level of interest rates and in other
circumstances permitted by the CFTC. A Portfolio may purchase an interest rate
futures contract when it intends to purchase debt securities but has not yet
done so. This strategy may minimize the effect of all or part of an increase in
the market price of the debt securities that the Portfolio intends to purchase
in the future. A rise in the price of the debt securities prior to their
purchase may be either offset by an increase in the value of the futures
contract purchased by a Portfolio or avoided by taking delivery of the debt
securities under the futures contract. Conversely, a fall in the market price of
the underlying debt securities may result in a corresponding decrease in the
value of the futures position. A Portfolio may sell an interest rate futures
contract in order to continue to receive the income from a debt security, while
endeavoring to avoid part or all of the decline in market value of that security
that would accompany an increase in interest rates.
A Portfolio may sell bond index futures contracts in anticipation of a
general market or market sector decline that could adversely affect the market
value of the Portfolio's securities. To the extent that a portion of a
Portfolio's portfolio correlates with a given index, the sale of futures
contracts on that index could reduce the risks associated with a market decline
and thus provide an alternative to the liquidation of securities positions. For
example, if a Portfolio correctly anticipates a general market decline and sells
bond index futures to hedge against this risk, the gain in the futures position
should offset some or all of the decline in the value of the Portfolio. A
Portfolio may purchase bond index futures contracts if a significant market or
market sector advance is anticipated. Such a purchase of a futures contract
would serve as a temporary substitute for the purchase of individual debt
securities, which debt securities may then be purchased in an orderly fashion.
This strategy may minimize the effect of all or part of an increase in the
market price of securities that a Portfolio intends to purchase. A rise in the
price of the securities should be partly or wholly offset by gains in the
futures position.
The settlement price of a futures contract is generally a function of
the spot market price of the underlying security and a cost of financing,
adjusted for any interest, dividends or other income received on the underlying
instrument over the life of the contract. It is therefore possible to earn a
return approximating that of debt securities of a similar tenor to that of a
forward contract by security or basket of securities and selling a futures
contract for such security or basket. A Portfolio may enter into such future
strategies, using securities other than debt obligations, in cases where (a)
government regulations restrict foreign investment in fixed income securities
but not in other securities, such as common stocks, or commodities; and (b) in
the Adviser's opinion both the cash and futures markets are sufficiently liquid.
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.
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.
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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. The 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. A Portfolio will be considered
"covered" with respect to a put option it writes on a futures contract if it
owns an option to sell that futures contract having a strike price equal to or
greater 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 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, currency or other financial index futures contracts to hedge its portfolio
against the risk of a decline in the market value of the securities it owns.
Anticipatory Hedging. A Portfolio may also purchase call options on
futures contracts as a hedge against an increase in the value of securities it
intends to acquire.
Writing a put option on a futures contract may serve as a partial
anticipatory hedge against an increase in the value of securities a Portfolio
intends to acquire. If the futures price at expiration of the option is above
the exercise price, a Portfolio retains the full amount of the option premium
which provides a partial hedge against any increase that may have occurred in
the price of the 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, a Portfolio would incur a loss, which may be wholly or
partially offset by the decrease in the value of the securities it intends to
acquire.
Whether an option on a futures contract is subject to the 5% CFTC
limit depends on whether use of the option constitutes a bona fide hedge.
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<PAGE>
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 market values fall.
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, a
Portfolio would retain the full amount of the option premium, increasing its
income. If the futures price when the option is exercised is above the exercise
price, however, a 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
portfolio securities. The amount of the premium received acts as a partial
hedge against any decline that may have occurred in the market value of a
Portfolio's securities.
A Portfolio's use of futures contracts and related options may not be
successful and it may incur losses in connection with its purchase and sale of
future contracts and related options.
Futures Straddles. A Portfolio may also purchase and write covered
-----------------
straddles on interest rate, foreign currency or bond index futures contracts. A
long straddle is a combination of a call and a put purchased on the same futures
contract where the exercise price of the put option is less than the exercise
price of the call option. A Portfolio would enter into a long straddle when it
believes that it is likely that interest rates or foreign currency exchange
rates will be more volatile during the term of the options than the option
pricing implies. A short straddle is a combination of a call and put written on
the same futures contract where the exercise price of the put option is less
than the exercise price of the call option and where the same security or
futures contract is considered for both the put and the call. The Portfolio
would enter into a short straddle when it believes that it is unlikely that
interest rates or foreign currency exchange rates will be as volatile during the
term of the options as the option pricing implies.
Special Characteristics and Risks of Futures Trading. No price is
----------------------------------------------------
paid upon entering into a futures contract. Instead, upon entering into a
futures contract, a Portfolio will be required to deposit with its custodian the
initial margin. Unlike margin in securities transactions, margin on futures
contracts a Portfolio has written does not involve borrowing to finance the
futures transactions. Rather, initial margin on futures contracts or on such
options is in the nature of a performance bond or good-faith deposit on the
contract that will be returned to the Portfolio upon termination of the
transaction, assuming all contractual obligations have been satisfied.
Similarly, variation margin does not involve borrowing to finance the futures,
but rather represents a daily settlement of a Portfolio's obligations to or from
a clearing organization.
Positions in futures contracts may be closed only on an exchange or
board of trade providing a secondary market for such futures. A Portfolio will
incur brokerage fees and related transaction costs when it purchases or sells
futures contracts and premiums.
Under certain circumstances, futures exchanges may establish daily
limits on the amount that the price of a futures contract may vary either up or
down from the previous day's settlement price. Once the daily limit has been
reached in a particular contract, no trades may be made that day at a price
beyond that limit. The daily limit governs only price movements during a
particular trading day and, therefore, does not limit potential losses because
futures prices could move to the daily limit for several consecutive trading
days with little or no trading and thereby prevent prompt liquidation of
positions. In such event, it may not be possible for the Portfolio to close a
position and, in the event of adverse price
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<PAGE>
movements, the Portfolio would have to make daily cash payments of variation
margin (except in the case of purchased options). However, in the event futures
contracts have been used to hedge fund securities, such securities will not be
sold until the contracts can be terminated. In such circumstances, an increase
in the price of the securities, if any, may partially or completely offset
losses on the futures contract. However, there is no guarantee that the price of
the securities will, in fact, correlate with the price movements in the
contracts and thus provide an offset to losses on the contracts.
The following considerations are important in deciding whether to use
futures contracts:
(1) Successful use by a Portfolio of futures contracts will depend
upon the Adviser's ability to predict movements in the direction of the overall
securities, currency and interest rate markets, which requires skills and
techniques that are different from those needed to predict changes in the prices
of individual securities. Moreover, futures contracts relate not to the current
price level of the underlying instrument or currency but to the anticipated
levels at some point in the future. There is, in addition, the risk that the
movements in the price of the futures contract will not correlate with the
movements in prices of the securities or currencies being hedged. For example,
if the price of the futures contract moves less than the price of the securities
or currencies that are the subject of the hedge, the hedge will not be fully
effective; however, if the price of securities or currencies being hedged has
moved in an unfavorable direction, a Portfolio would be in a better position
than if it had not hedged at all. If the price of the securities being hedged
has moved in a favorable direction, the advantage may be partially offset by
losses on the futures position. In addition, if a Portfolio has insufficient
cash, it may have to sell portfolio investments to meet daily variation margin
requirements. Any such sale of assets may or may not be made at prices that
reflect the rising market. Consequently, the Portfolio may need to sell assets
at a time when such sales are disadvantageous to the Portfolio. If the price of
the futures contract moves more than the price of the underlying securities or
currencies, a Portfolio will experience either a loss or a gain on the futures
contract that may or may not be completely offset by movements in the price of
the securities or currencies that are the subject of the hedge.
(2) In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between price movements in the futures
position and the securities or currencies being hedged, movements in the prices
of futures contracts may not correlate perfectly with movements in the prices of
the hedged securities or currencies due to price distortions in the futures
market. There may be several reasons unrelated to the value of the underlying
securities or currencies that cause this situation to occur. First, as noted
above, all participants in the futures market are subject to initial and
variation margin requirements. If, to avoid meeting additional margin deposit
requirements or for other reasons, investors choose to close a significant
number of futures contracts through offsetting transactions, distortions in the
normal price relationship between the securities or currencies and the futures
markets may occur. Second, because the margin deposit requirements in the
futures market are less onerous than margin requirements in the securities
market, there may be increased participation by speculators in the futures
market; such speculative activity in the futures market also may cause temporary
price distortions. Third, participants could make or take delivery of the
underlying securities or currencies instead of closing out their contracts. As
a result, a correct forecast of general market trends may not result in
successful hedging through the use of futures contracts over the short term. In
addition, activities of large traders in both the futures and securities markets
involving arbitrage and other investment strategies may result in temporary
price distortions.
(3) Positions in futures contracts may be closed out only on an
exchange or board of trade that provides a secondary market for such futures
contracts. Although each Portfolio intends to purchase or sell futures only on
exchanges or boards of trade where there appears to be an active secondary
market, there is no assurance that a liquid secondary market on an exchange or
board of trade will exist for any particular contract at any particular time.
In such event, it may not be possible to close a
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futures position, and in the event of adverse price movements, a Portfolio would
continue to be required to make variation margin payments.
(4) As is the case with options, a Portfolio's activities in the
futures markets may result in higher fund turnover rates and additional
transaction costs in the form of added brokerage commissions; however, the
Portfolio may save on commissions by using futures contracts or options thereon
as a hedge rather than buying or selling individual securities or currencies in
anticipation or as a result of market movements.
Guideline for Futures. No Portfolio will purchase or sell futures
---------------------
contracts if, immediately thereafter, the sum of the amount of initial margin
deposits on the Portfolio's existing futures positions and initial margin
deposits would exceed 5% of the market value of the Portfolio's total assets.
This guideline may be modified by the board without shareholder vote. Adoption
of this guideline will not limit the percentage of the Portfolio's assets at
risk to 5%.
Forward Foreign Currency Contracts. Each Portfolio, other than the
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Money Market Portfolio, may enter into forward contracts. The High Yield
Portfolio may invest up to 5% of its total assets in these instruments. A
Portfolio may engage in foreign currency hedging strategies, including among
others, settlement hedging, transaction hedging, position hedging, proxy hedging
and cross-hedging. A "settlement hedge" or "transaction hedge" is designed to
protect the Portfolio against an adverse change in foreign currency values
between the date a security is purchased or sold and the date on which payment
is made or received. Entering into a forward contract for the purchase or sale
of the amount of foreign currency involved in an underlying security transaction
for a fixed amount of U.S. dollars "locks in" the U.S. dollar price of the
security. A Portfolio may also use forward contracts to purchase or sell a
foreign currency in anticipation of future purchases or sales of securities
denominated in foreign currency, even if the Adviser has not yet selected the
specific investments.
A Portfolio may also use forward contracts to hedge against a decline
in the value of existing investments denominated in a foreign currency. For
example, if a Portfolio owns securities denominated in a particular currency, it
could enter into a forward contract to sell that particular currency in return
for U.S. dollars to hedge against possible declines in the particular currency's
value. Such a hedge, sometimes referred to as a "position hedge," would tend to
offset both positive and negative currency fluctuations, but would not offset
changes in security values caused by other factors. A Portfolio could also
hedge the position by selling another currency (or basket of currencies)
expected to perform similarly to a particular currency. This type of hedge,
sometimes referred to as a "proxy hedge," could offer advantages in terms of
cost, yield, or efficiency, but generally would not hedge currency exposure as
effectively as a direct hedge into U.S. dollars. Proxy hedges may result in
losses if the currency used to hedge does not perform similarly to the currency
in which the hedged securities are denominated. With regard to a Portfolio's
use of proxy hedges, historical correlations between the movement of certain
foreign currencies relating to the U.S. dollar may not continue. Thus, at any
time poor correlation may exist between movements in the exchange rates of the
foreign currencies underlying the Portfolio's proxy hedges and the movements in
the exchange rates of the foreign currencies in which the Portfolio assets that
are the subject of such proxy-hedges are denominated.
A Portfolio may enter into forward contracts to shift its investment
exposure from one currency into another. This may include shifting exposure
from U.S. dollars to a foreign currency. This type of strategy, sometimes known
as a "cross-hedge," will tend to reduce or eliminate exposure to the currency
that is sold, and increase exposure to the currency that is purchased, much as
if a Portfolio had sold a security denominated in one currency and purchased an
equivalent security denominated in another. Cross-hedges protect against losses
resulting from a decline in the hedged currency, but will cause a Portfolio to
assume the risk of fluctuations in the value of the currency it purchases.
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Successful use of currency management strategies will depend on the
Adviser's skill in analyzing currency values. Currency management strategies may
substantially change a Portfolio's investment exposure to changes in currency
exchange rates and could result in losses to the Portfolio if currencies do not
perform as the Adviser anticipates. For example, if a currency's value rose at a
time when the Adviser had hedged a Portfolio by selling that currency in
exchange for dollars, the Portfolio would not participate in the currency's
appreciation. If the Adviser hedges currency exposure through proxy hedges, a
Portfolio could realize currency losses from both the hedge and the security
position if the two currencies do not move in tandem. Similarly, if the Adviser
increases a Portfolio's exposure to a foreign currency and that currency's value
declines, the Portfolio will realize a loss. The Adviser's use of currency
management strategies may not be advantageous to a Portfolio and the Adviser may
not hedge at appropriate times.
A forward foreign currency exchange contract involves an obligation to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. These contracts are traded in the
interbank market conducted directly between currency traders (usually large
commercial banks) and their customers. A forward contract generally has no
deposit requirement, and no commissions are generally charged at any stage for
trades.
At the maturity of a forward contract, a Portfolio may either accept
or make delivery of the currency specified in the contract or, at or prior to
maturity, enter into a closing purchase transaction involving the purchase or
sale of an offsetting contract. Closing purchase transactions with respect to
forward contracts are usually effected with the currency trader who is a party
to the original forward contract.
A Portfolio may enter into forward currency contracts to purchase or
sell foreign currencies for a fixed amount of U.S. dollars or another foreign
currency for any lawful purpose. For example, a Portfolio may purchase a
forward currency contract to lock in the U.S. dollar price of a security
denominated in a foreign currency that the Portfolio intends to acquire. In
addition, a Portfolio may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
The cost to a Portfolio of engaging in forward currency contracts
varies with factors such as the currency involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees or commissions
are involved. When a Portfolio enters into a forward currency contract, it
relies on the counterparty to make or take delivery of the underlying currency
at the maturity of the contract. Failure by the counterparty to do so would
result in the loss of any expected benefit of the transaction.
Settlement of hedging transactions involving foreign currencies might
be required to take place within the country issuing the underlying currency.
Thus, a Portfolio might be required to accept or make delivery of the underlying
foreign currency in accordance with any U.S. or foreign regulations regarding
the maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
A Portfolio may also create non-speculative "synthetic" positions. A
synthetic position is deemed not to be speculative if the position is covered by
segregation of short-term liquid assets. A synthetic position is the
duplication of a cash market transaction when the Adviser deems it to be
advantageous for cost liquidity or transactional efficiency reasons. A cash
market transaction is the purchase or sale of a security or other asset for
cash. For example, a Portfolio may experience large cash inflows which may be
redeemed from the Portfolio in a relatively short period. In this case, the
Portfolio
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can leave the amounts uninvested in anticipation of the redemption or the
Portfolio can invest in securities for a relatively short period, incurring
transaction costs on the purchase and subsequent sale. Alternatively, the
Portfolio could create a synthetic position by investing in a futures contract
on a security, such as a bond denominated in a foreign currency or on a
securities index gaining investment exposure to the relevant market while
incurring lower overall transaction costs. Since the financial markets in
emerging countries are not as developed as in the United States, these financial
investments may not be available to a Portfolio and the Portfolio may be unable
to hedge certain risks or enter into certain transactions. A Portfolio would
enter into such transactions if the markets for these instruments were
sufficiently liquid and there was an acceptable degree of correlation to the
cash market. By segregating cash, a Portfolio's futures contract position would
generally be no more leveraged or riskier than if it had invested in the cash
market i.e., purchased securities.
As is the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument held or written. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the counterparty. Thus, a Portfolio may not in fact
be able to close out a forward currency contract at a favorable price prior to
maturity. In addition, in the event of insolvency of the counterparty, a
Portfolio might be unable to close out a forward currency contract at any time
prior to maturity. In either event, the Portfolio would continue to be subject
to market risk with respect to the position, and would continue to be required
to maintain a position in securities denominated in the foreign currency or to
maintain cash or securities in a segregated account.
The precise matching of forward currency contract amounts and the
value of the securities involved generally will not be possible because the
value of such securities, measured in the foreign currency, will change after
the foreign currency contract has been established. Thus, a Portfolio might
need to purchase or sell foreign currencies in the spot (cash) market to the
extent such foreign currencies are not covered by forward contracts. The
projection of short-term currency market movements is extremely difficult, and
the successful execution of a short-term hedging strategy is highly uncertain.
Unless a Portfolio engages in currency hedging transactions, it will
be subject to the risk of changes in relation to the U.S. dollar of the value of
the currencies in which its assets are denominated. A Portfolio may from time
to time seek to protect, during the period prior to the remittance, the value of
the amount of interest, dividends and net realized capital gains received or to
be received in a local currency that it intends to remit out of the foreign
country by investing in high-quality short-term U.S. dollar-denominated debt
securities of such country and/or participating in the forward currency market
for the purchase of U.S. dollars in the country. Suitable U.S. dollar-
denominated investments may not be available at the time the Adviser wishes to
use them to hedge amounts to be remitted. In addition, dollar-denominated
securities may not be available in some or all emerging countries, that the
forward currency market for the purchase of U.S. dollars in many emerging
countries is not highly developed and that in certain emerging countries no
forward market for foreign currencies currently exists or that such market may
be closed to investment by a Portfolio.
A separate account of a Portfolio consisting of cash or liquid
securities equal to the amount of the Portfolio's assets that could be required
to consummate forward contracts, when required under applicable laws, will be
established with the Portfolio's Custodian. For the purpose of determining the
adequacy of the assets in the account, the deposited assets will be valued at
market or fair value. If the market or fair value of such assets declines,
additional cash or assets will be placed in the account daily so that the value
of the account will equal the amount of such commitments by the Portfolio. The
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segregated account will be marked-to-market on a daily basis. Although the
contracts are not presently regulated by the CFTC, the CFTC may in the future
assert authority to regulate these contracts. In such event, a Portfolio's
ability to utilize forward foreign currency exchange contracts may be
restricted.
The precise matching of the forward contract amounts and the value of
the securities involved will not generally be possible because the future value
of such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date the forward contract
is entered into and the date it matures. Accordingly, it may be necessary for a
Portfolio to purchase additional foreign currency on the spot (i.e., cash)
market (and bear the expense of such purchase) if the market value of the
security is less than the amount of foreign currency the Portfolio is obligated
to deliver and if a decision is made to sell the security and make delivery of
the foreign currency. Conversely, it may be necessary to sell on the spot market
some of the foreign currency received upon the sale of the Portfolio security if
its market value exceeds the amount of foreign currency the Portfolio is
obligated to deliver. The projection of short-term currency market movements is
extremely difficult, and the successful execution of a short-term hedging
strategy is highly uncertain. Forward contracts involve the risk that
anticipated currency movements will not be accurately predicted, causing the
Portfolio to sustain losses on these contracts and transaction costs. A
Portfolio may enter into a forward contract and maintain a net exposure on such
contract only if (1) the consummation of the contract would not obligate the
Portfolio to deliver an amount of foreign currency in excess of the value of the
Portfolio's securities or other assets denominated in that currency or (2) the
Portfolio maintains cash or liquid assets in a segregated account in an amount
not less than the value of the Portfolio's total assets committed to the
consummation of the contract which value must be marked to market daily. Each
Portfolio will comply with guidelines established by the SEC with respect to
coverage of forward contracts entered into by the Portfolio (including SEC
guidelines in respect of forward contracts subject to netting arrangements) and,
if such guidelines so require, will set aside liquid assets in a segregated
account with its custodian in the amount prescribed. Under normal circumstances,
consideration of the prospect for currency parities will be incorporated into
the longer term investment decisions made with regard to overall diversification
strategies. However, the Adviser believes that it is important to have the
flexibility to enter into such forward contracts when it determines that the
best interests of a Portfolio will be served.
At or before the maturity date of a forward contract requiring a
Portfolio to sell a currency, the Portfolio may either sell the portfolio
security and use the sale proceeds to 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 that it is obligated to
deliver. Similarly, a Portfolio may close out a forward contract requiring it
to purchase a specified currency by entering into a second contract entitling it
to sell the same amount of the same currency on the maturity date of the first
contract. A Portfolio would realize a gain or loss as a result of entering into
such an offsetting forward currency contract under either circumstance to the
extent the exchange rate or rates between the currencies involved moved between
the execution dates of the first contract and the offsetting contract.
The cost to a Portfolio of engaging in forward currency contracts will
vary with factors such as the currencies involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees or commissions
are involved. The use of forward currency contracts will not eliminate
fluctuations in the prices of the underlying securities a Portfolio owns or
intends to acquire, but it will fix a rate of exchange in advance. In addition,
although forward currency contracts limit the risk of loss due to a decline in
the value of the hedged currencies, at the same time they limit any potential
gain that might result should the value of the currencies increase.
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Although a Portfolio will value its assets daily in terms of U.S.
dollars, the Portfolio does not intend to convert its holdings of foreign
currencies into U.S. dollars on a daily basis. A Portfolio may convert foreign
currency 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 between the prices
at which they are buying and selling various currencies. Thus, a dealer may
offer to sell a foreign currency to a Portfolio at one rate, while offering a
lesser rate of exchange should the Portfolio desire to resell that currency to
the dealer.
A Portfolio generally will not enter into a forward contract with a
term of greater than one year.
Swaps, Caps, Floors and Collars. The Income, High Yield, EMD, Large
-------------------------------
Cap, Small Cap and Balanced Portfolios each may engage in swaps. The High Yield
and the Balanced Portfolios each may invest up to 5% of its total assets in
these instruments. A Portfolio may enter into currency swaps, mortgage swaps,
index swaps and interest rate swaps, caps, floors and collars. A Portfolio may
enter into currency swaps for both hedging purposes and to seek to increase
total return. In addition, a Portfolio may 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 a Portfolio with another party of their
respective rights to make or receive payments in specified currencies. Interest
rate swaps involve the exchange by a 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 swaps involve the exchange by a 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 a Portfolio is contractually
obligated to make. If the other party to an interest rate, index or mortgage
swap defaults, a 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 a 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; the Adviser 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.
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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 the Adviser. If there is a
default by the other party to a swap transaction, a Portfolio will have
contractual remedies pursuant to the agreements related to the transaction.
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 the Adviser 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 SEC currently takes the
position that swaps, caps, floors and collars are illiquid and thus subject to a
Portfolio's 15% limitation on investments in illiquid securities.
Lending Portfolio Securities. Each Portfolio, other than the Money
----------------------------
Market Portfolio, may lend its portfolio securities. The High Yield Portfolio
may lend portfolio securities with a market value of up to 30% of its total
assets and each other Portfolio that can lend portfolio securities can do so up
to 33-1/3% of its total assets. A 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 Portfolio's investment standards to be the
equivalent of cash. From time to time, a Portfolio may return to the borrower
(or a third party that is unaffiliated with such Portfolio) and that is acting
as a "placing broker," a part of the interest earned from the investment of
collateral received for securities loaned.
The SEC currently requires that the following conditions must be met
whenever portfolio securities are loaned: (1) the lender 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) the lender must be able to terminate the loan at any time;
(4) the lender 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) the lender 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 Board must terminate the loan and
regain the right to vote the securities if a material event adversely affecting
the investment occurs.
The Portfolios (other than the EMD Portfolio) have appointed Custodial
Trust Company ("CTC"), an affiliate of BSAM, as Lending Agent. CTC receives a
transaction fee for its services. The Trust, CTC, Bear Stearns and other
affiliates have applied to the SEC for an exemptive order that would, among
other things, permit the Portfolios to: (a) pay to CTC, or any of its
affiliates, fees based on a share of the proceeds derived by the Portfolios from
securities lending transactions; (b) deposit some or all of the cash collateral
received in connection with their securities lending activities and other
uninvested cash in one or more joint trading accounts; and (c) lend portfolio
securities to any affiliated broker-dealers, including Bear Stearns.
Non-Diversified Status. A non-diversified fund, within the meaning of
----------------------
the 1940 Act, means that the fund is not limited by such Act in the proportion
of its assets that it may invest in securities of a single issuer. The Adviser
intends to limit a non-diversified Portfolio's investments, however, in order to
qualify as a "regulated investment company" for the purposes of Subchapter M of
the Code. See "Taxes." To qualify, a non-diversified Portfolio must comply
with certain requirements, including limiting its investments so that at the
close of each quarter of the taxable year (i) not more than 25% of
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the value of the Portfolio's total assets will be invested in the securities of
a single issuer, and (ii) with respect to 50% of the value of its total assets,
not more than 5% of the value of the Portfolio's total assets will be invested
in the securities of a single issuer and the Portfolio will not own more than
10% of the outstanding voting securities of a single issuer. To the extent that
a non- diversified Portfolio assumes large positions in the securities of a
small number of issuers, the Portfolio's return may fluctuate to a greater
extent than that of a diversified investment company as a result of changes in
the financial condition or in the market's assessment of the issuers.
Short Selling. The Insiders Select Fund and the Income, High Yield,
-------------
S&P STARS, Large Cap and Small Cap Portfolios may engage in short sales. Short
sales are transactions in which an investor sells a security it does not own in
anticipation of a decline in the market value of that security. To complete
such a transaction, the investor must borrow the security to make delivery to
the buyer. The investor then is obligated to replace the security borrowed by
purchasing it at the market price at the time of replacement. The price at such
time may be more or less than the price at which the security was sold by the
investor. Until the security is replaced, the investor is required to pay to
the lender amounts equal to any dividend which accrues during the period of the
loan. To borrow the security, an investor also may be required to pay a
premium, which would increase the cost of the security sold. The proceeds of
the short sale will be retained by the broker, to the extent necessary to meet
margin requirements, until the short position is closed out.
Until a Portfolio replaces a borrowed security in connection with a
short sale, the Portfolio will: (a) maintain daily a segregated account,
containing liquid securities, at such a level that the amount deposited in the
account plus the amount deposited with the broker as collateral always equals
the current value of the security sold short; or (b) otherwise cover its short
position in accordance with positions taken by the staff of the SEC.
A Portfolio will incur a loss as a result of the short sale if the
price of the security increases between the date of the short sale and the date
on which the Portfolio replaces the borrowed security. A Portfolio will realize
a gain if the security declines in price between those dates. This result is
the opposite of what one would expect from a cash purchase of a long position in
a security. The amount of any gain will be decreased, and the amount of any loss
increased, by the amount of any premium or amounts in lieu of interest a
Portfolio may be required to pay in connection with a short sale. Each
Portfolio may purchase call options to provide a hedge against an increase in
the price of a security sold short by a Portfolio.
Each Portfolio anticipates that the frequency of short sales will vary
substantially in different periods, and it does not intend that any specified
portion of its assets, as a matter of practice, will be invested in short sales.
However, no securities will be sold short if, after effect is given to any such
short sale, the total market value of all securities sold short would exceed 25%
of the value of a Portfolio's net assets. No Portfolio may sell short the
securities of any single issuer listed on a national securities exchange to the
extent of more than 5% of the value of its net assets. No Portfolio may sell
short the securities of any class of an issuer to the extent, at the time of the
transaction, of more than 2% of the outstanding securities of that class.
Short Sales "Against the Box." The Insiders Select Fund and the
------------------------------
Income, S&P STARS, Focus List, Large Cap, Small Cap and Balanced Portfolios at
no time will have more than 15% of the value of its net assets in deposits on
short sales against the box and neither the High Yield Portfolio nor the
International Equity Portfolios at any time will have more than 25% of its net
assets in deposits on short sales against the box. A Portfolio may make short
sales "against the box," a transaction in which a Portfolio enters into a short
sale of a security which the Portfolio owns. The proceeds of the short sale
will be held by a broker until the settlement date, at which time a Portfolio
delivers be security to close
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the short position. A Portfolio receives the net proceeds from the short sales.
It currently is anticipated that each Portfolio will make short sales against
the box for purposes of protecting the value of the Portfolio's net assets.
Additional Information about the S&P STARS Portfolio's Investment
-----------------------------------------------------------------
Strategies. As described in the Prospectus, the principal strategy of the S&P
----------
STARS Portfolio is to invest at least 85% of its total assets in securities
rated 5-STAR at their time of purchase, or to sell short securities rated 1-STAR
at their time of short sale. The remaining 15% of the Portfolio's assets may be
invested in securities without regard to ratings by S&P (the "15% bucket").
Generally, STAR rankings are determined "at their time of purchase" or
"at their time of short sale." Compliance with the STAR rankings for purposes of
the 15% bucket test is measured on any given day without giving effect to
securities transactions executed on that day. Securities transactions executed
on any given day are given effect for purposes of the 15% bucket test on the
start of the following day. Cash and cash equivalents are counted as part of the
Portfolio's total assets, but do not count as part of the 15% bucket for
purposes of determining compliance.
The 15% bucket includes securities that are rated below 5-STAR at the
time of purchase, and securities sold short that are rated above 1-STAR at the
time of sale. Once the 15% bucket is full, the Portfolio cannot continue to
purchase non 5-STAR rated securities, or sell non 1-STAR rated securities,
unless under one of the following two exceptions. First, if the Portfolio buys a
5-STAR rated stock that S&P later downgrades to a 4-STAR rating, that stock is
not included in the 15% bucket, and the Portfolio may continue to hold that
stock, and, going forward, may purchase more shares of that stock, without
regard to the 15% limitation as long as it is rated 4-STAR. Second, if the
Portfolio has sold short a 1-STAR rated stock that is later upgraded to 2-STARS,
that stock is not included in the 15% bucket, and the Portfolio may continue to
maintain its short position in that stock and, going forward, may sell short
more shares of that stock, without regard to the 15% limitations as long as it
is rated 2-STAR.
Under certain circumstances, the Portfolio's holdings of securities
rated 3-STAR (or less) and/or short positions in securities rated 3-STAR (or
more) can exceed 15% of its total assets without being a violation of the 15%
bucket test. These circumstances include:
o situations where the 15% bucket is exceeded because of changes in net
assets due to market appreciation, depreciation or share redemptions;
o situations where S&P downgrades a stock to 3-STARS or below;
o situations where S&P upgrades a stock that the Portfolio has sold
short to 3-STARS or higher; and
o situations where, by a corporate action, a 5-STAR stock (or 4-STAR
stock that was previously rated 5-STARS while held by the Portfolio)
is split or spun off into two or more stocks rated below 4-STARS, or
unrated.
However, in all of these situations, if the 15% bucket is full or overflowing,
the Portfolio cannot buy additional non 5-STAR rated stock, or sell non 1-STAR
rated stock, except under the two exceptions described above.
41
<PAGE>
If S&P upgrades a stock to 5-STARS, that the Portfolio owns that stock
is considered to be a 5-STAR stock for all purposes. For example, if the
Portfolio has invested 4% of its assets in a stock rated 3-STARS, and if S&P
upgrades the stock to 5-STARS, that stock is no longer counted in the 15%
bucket. Moreover, if S&P upgrades a 3-STAR stock to a 5-STAR stock, and later
downgrades it to a 4-STAR stock, the Portfolio may continue to own and purchase
more shares of that stock under the first exception described above. Similarly,
if S&P downgrades a security that the Portfolio has sold short to 1-STAR, that
stock is considered to be a 1-STAR stock for all purposes, and is not counted in
the 15% bucket.
As described in the Prospectus, the S&P STARS Portfolio need not
sell a security whose S&P STARS ranking has been downgraded and the Portfolio
may purchase additional shares of a four star security that was rated five stars
at the time it was initially purchased. If the S&P STARS ranking of that
security is downgraded to three stars or less, however, that security is counted
toward the 15% of total assets that the S&P STARS Portfolio may invest without
regard to STARS ranking.
Similarly, the S&P STARS Portfolio need not buy back a one star
security it has sold short if the STARS ranking of the security is upgraded and
the Portfolio may sell short additional shares of a two star security that was
rated one star at the time it was initially sold short. If the S&P STARS
ranking of that security is upgraded to three or more stars, however, that
security is counted toward the 15% of total assets that the S&P STARS Portfolio
may invest without regard to STARS ranking.
At any time that the S&P STARS Portfolio's holdings of securities
rated three stars (or less) and/or short positions in securities rated three
stars (or more) exceed 15% of its total assets, the Portfolio may not acquire or
sell short additional shares of such securities until the amount so invested
declines below 15% of total assets.
Investment Restrictions. Each Portfolio has adopted certain
-----------------------
investment restrictions as fundamental policies. These restrictions cannot be
changed without the approval of a majority of the Portfolio's outstanding voting
shares (as defined in the 1940 Act). Investment restrictions that are not
fundamental policies may be changed by vote of a majority of the Trustees at any
time. 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.
Fundamental Restrictions
1. Concentration
The Money Market Portfolio may not purchase any securities which 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 or in bank
instruments issued by domestic banks.
The Insiders Select Fund and the Income, High Yield, S&P STARS, Large
Cap, Small Cap, Focus List, Balanced and International Equity Portfolios each
may not purchase any securities which 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.
The EMD Portfolio may not invest more than 25% of the value of its
total assets in the securities of one or more issuers conducting their principal
business activities in the same industry. This
42
<PAGE>
limitation is not applicable to investments in obligations of the U.S.
government or any of its agencies or instrumentalities. For purposes of the EMD
Portfolio's Investment Restriction relating to Concentration, as long as the
staff of the SEC considers securities issued or guaranteed as to principal and
interest by any single foreign government or any supranational organization in
the aggregate to be securities of issuers in the same industry, the Portfolio
intends to comply with such SEC staff position.
2. Diversification
The Money Market Portfolio may not purchase securities of any one
issuer if as a result more than 5% of the value the Portfolio's assets would be
invested in the securities of such issuer, except that up to 25% of the value of
the Portfolio's total assets may be invested without regard to such 5%
limitation and provided that there is no limitation with respect to investments
in U.S. government securities and domestic bank instruments.
The Income, Large Cap and Small Cap Portfolios each may not 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. Single Issuer
The Income, Large Cap and Small Cap Portfolios each may not 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. Commodities
The Money Market Portfolio may not purchase or sell commodities
contracts, or invest in oil, gas or mineral exploration or development programs
or in mineral leases.
The EMD Portfolio may not purchase or sell commodities or commodity
contracts, except that the Portfolio may (a) purchase and sell futures
contracts, including those relating to securities, currencies and indices, and
(b) purchase and sell currencies or securities on a forward commitment or
delayed-delivery basis.
Each Portfolio, other than the Money Market and EMD Portfolios, may
not invest in commodities, except that each such Portfolio may purchase and sell
options, forward contracts, futures contracts, including those relating to
indexes, and options on futures contracts or indexes.
5. Real Estate
The Money Market Portfolio may not purchase or sell real estate or
real estate limited partnerships, provided that the Portfolio may purchase
securities of issuers which invest in real estate or interests therein.
The EMD Portfolio may not purchase, hold or deal in real estate,
including limited partnership interests, or oil, gas or other mineral leases,
although the Portfolio may purchase and sell securities that are secured by real
estate or interests therein and may purchase mortgage-related securities and may
hold and sell real estate acquired by the Portfolio as a result of the ownership
of securities.
43
<PAGE>
Each Portfolio, other than the Money Market and EMD Portfolios, may
not 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 such 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. Borrowing
The Money Market Portfolio may not borrow money, except that the
Portfolio may (i) borrow money for temporary or emergency purposes from banks
or, subject to specific authorization by the SEC, from funds advised by the
Adviser to an affiliate of the Adviser, and (ii) engage in reverse repurchase
agreements; provided that (i) and (ii) in combination do not exceed one-third of
the value of the Portfolio's total assets (including the amount borrowed) less
liabilities (other than borrowings).
The EMD Portfolio may not borrow money, except from banks, and only if
after such borrowing there is asset coverage of at least 300% for all borrowings
of the Portfolio; or mortgage, pledge or hypothecate its assets except in
connection with such borrowings. This restriction shall not prevent the
Portfolio from entering into reverse repurchase agreements, provided that
reverse repurchase agreements and any other transactions constituting borrowing
by the Portfolio may not exceed 10% of the Portfolio's total assets. In the
event that the asset coverage for the Portfolio's borrowings falls below 300%,
the Portfolio will reduce within three days the amount of its borrowings in
order to provide for 300% asset coverage. (For the purpose of this restriction,
collateral arrangements with respect to the writing of options, and, if
applicable, futures contracts, and collateral arrangements with respect to
initial and variation margin are not deemed to be a pledge of assets and neither
such arrangements nor the purchase or sale of futures are deemed to be the
issuance of a senior security for purposes of the Investment Limitation related
to Senior Securities.)
Each Portfolio, other than the Money Market and EMD Portfolios, may
not 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. Lending
The Money Market Portfolio may not make loans, except that the
Portfolio may (i) purchase or hold debt obligations in accordance with its
investment objective and policies, (ii) enter into repurchase agreements for
securities, (iii) subject to specific authorization by the SEC, lend money to
other funds advised by the Adviser or an affiliate of the Adviser.
The EMD Portfolio may not make loans, except that the Portfolio may
(a) purchase and hold debt instruments (including bonds, debentures or other
debt instruments or interests therein, government obligations, short-term
commercial paper, certificates of deposit and bankers acceptances) in accordance
with its investment objectives and policies, (b) invest in emerging country
loans, participations and assignments, (c) enter into repurchase agreements with
respect to portfolio securities, and (d) make loans of portfolio securities.
Each Portfolio, other than the Money Market and EMD Portfolios, may
not make loans to others, except through the purchase of debt obligations and
the entry into repurchase agreements. However, each such Portfolio may lend its
portfolio securities in an amount not to exceed 33-1/3% of the
44
<PAGE>
value of its total assets. Any loans of portfolio securities will be made
according to guidelines established by the SEC and the Board.
8. Underwriting
The Money Market Portfolio may not act as an underwriter of
securities, except insofar as the Portfolio may be deemed an underwriter under
applicable securities laws in selling portfolio securities.
The EMD Portfolio may not underwrite securities of other issuers,
except insofar as the Portfolio may be deemed to be an underwriter under the
Securities Act in selling portfolio securities.
Each Portfolio, other than the Money Market and EMD Portfolios, may
not act as an underwriter of securities of other issuers, except to the extent
each such Portfolio may be deemed an underwriter under the Securities Act, by
virtue of disposing of portfolio securities.
9. Senior Securities
The Money Market, High Yield, Large Cap, Focus List, Balanced and
International Equity Portfolios each may not issue any senior security (as such
term is defined in Section 18(f) of the 1940 Act) except that (a) each such
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) each such 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; and (c) subject to the
Investment Restriction related to Borrowing, each such Portfolio may borrow
money as authorized by the 1940 Act.
The Insiders Select Fund and the Income, S&P STARS and Small Cap
Portfolios each may not issue any senior security (as such term is defined in
Section 18(f) of the 1940 Act).
The EMD Portfolio may not issue any senior security (as such term is
defined in Section 18(f) of the 1940 Act) except as otherwise permitted in the
Investment Restrictions related to Borrowing, Short Sales and Lending; and, in
the case of the Investment Restrictions related to Short Sales and Lending,
provided the coverage requirements enunciated by the SEC are followed.
10. Margin
The Insiders Select Fund and the Income, S&P STARS, Large Cap and
Small Cap Portfolios each may not purchase securities on margin, but each such
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.
11. Unseasoned Issuers
The S&P STARS Portfolio may not 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 Portfolio's
investments, in all such companies to exceed 5% of the value of its total
assets.
45
<PAGE>
12. Management or Control
The S&P STARS Portfolio may not invest in the securities of a company
for the purpose of exercising management or control, but it will vote the
securities it owns in its portfolio as a shareholder in accordance with its
views.
Non-Fundamental Restrictions.
1. Pledging Assets
Each Portfolio, other than the Money Market and EMD Portfolios may not
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.
2. Options
The Money Market Portfolio may not write or sell puts, calls,
straddles, spreads or combinations thereof.
The Insiders Select Fund and the Income, S&P STARS, Large Cap and
Small Cap Portfolios each may not purchase, sell or write puts, calls or
combinations thereof, except as described in the Prospectus and SAI.
3. Other Investment Companies
The Money Market Portfolio may not purchase securities of other
investment companies except as permitted under the 1940 Act or in connection
with a merger, consolidation, acquisition, or reorganization.
Each Portfolio, other than the Money Market and EMD Portfolios, may
not purchase securities of other investment companies, except to the extent
permitted under the 1940 Act.
4. Unseasoned Issuers
The EMD Portfolio may not invest more than 10% of the value of its
total assets in securities of issuers having a record, together with
predecessors, of less then three years of continuous operation.
The Insiders Select Fund and the Large Cap Portfolio each may not
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 Portfolio's investments in all such companies to exceed
5% of the value of its total assets.
5. Management or Control
The EMD Portfolio may not make investments for the purpose of
exercising control or management. Investments by the Portfolio in wholly owned
investment entities created under the laws of
46
<PAGE>
certain countries will not be deemed the making of investments for the purpose
of exercising control or management.
The Insiders Select Fund and the Large Cap and Small Cap Portfolios
each may not invest in the securities of a company for the purpose of exercising
management or control, but each such Portfolio will vote the securities it owns
in its portfolio as a shareholder in accordance with its views.
6. Illiquid Securities
The Money Market Portfolio may not knowingly invest more than 10% of
the value of its 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.
The Insiders Select Fund and the Income, S&P STARS, Large Cap and
Small Cap Portfolios each may not 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.
The High Yield, Focus List, Balanced and International Equity
Portfolios each may not knowingly invest more than 15% of the value of its
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.
7. Margin
The Money Market Portfolio may not purchase securities on margin, make
short sales of securities, or maintain a short position.
The High Yield, Focus List, Balanced and International Equity
Portfolios each may not purchase securities on margin, but each such 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.
8. Short Sales
The EMD Portfolio may not make short sales of securities, except short
sales against-the-box, or maintain a short position. (The Portfolio does not
currently intend to make short sales against-the-box.)
The Focus List, Balanced and International Equity Portfolios each may
not make short sales of securities, other than short sales "against the box."
9. Investments while Borrowing.
The Money Market, High Yield, Focus List, Balanced and International
Equity Portfolios each may not make additional investments when borrowing
exceeds 5% of Portfolio assets.
10. Warrants
The Money Market Portfolio may not invest in warrants.
47
<PAGE>
MANAGEMENT OF THE TRUST
Trustees and officers of the Trust, together with information as to
their principal business occupations during at least the last five years, are
shown below. There is also one Advisory Trustee who attends meetings and serves
on committees but does not vote.
Each Trustee who is an "interested person" of the Trust, as defined in
the 1940 Act, is indicated by an asterisk. Sen. Dixon may be considered an
interested person because the law firm with which he is affiliated has performed
legal services for Bear Stearns.
<TABLE>
<CAPTION>
TRUSTEES AND OFFICERS
- ----------------------------------------------------------------------------------------------------------------------
Name, (age) and address Position with Trust Principal Occupation
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Peter M. Bren (67) Trustee President of The Bren Co. (realty).
126 East 56th Street
New York, NY 10021
- -----------------------------------------------------------------------------------------------------------------------
Doni L. Fordyce (40) * Trustee and Since 1996, Senior Managing Director of Bear Stearns;
575 Lexington Avenue President until 1996, Vice President, Asset Management Group,
New York, NY 10022 Goldman, Sachs & Co.
- -----------------------------------------------------------------------------------------------------------------------
John S. Levy (65) Trustee Since 1996, Managing Partner, Fayerweather Capital
Fayerweather Capital Partners Partners (a private investment partnership); from
595 Madison Avenue 1984 to 1995, Managing Director and Chief
New York, NY 10022 Administrative Officer of the Financial Services
Division of Lehman Brothers Inc. and Senior Executive
Vice President and Co-Director of International
Division of Shearson Lehman/American Express.
- -----------------------------------------------------------------------------------------------------------------------
Michael Minikes (57) * Trustee, Senior Managing Director of Bear Stearns; Treasurer
245 Park Avenue Chairman of and Director of The Bear Stearns Companies Inc.;
New York, NY 10167 the Board since 1997, Chairman of the Board of Trustees of the
Trust; since 1999, Co-President of Bear, Stearns
Securities Corp.
- -----------------------------------------------------------------------------------------------------------------------
M.B. Oglesby, Jr. (58) Trustee Since 1999, Consultant and Chairman of Oglesby
700 13th St., N.W., Suite 400 Properties, Inc.; since 1997, President and Chief
Washington, D.C. 20005 Executive Officer, Association of American Railroads;
from 1996 to 1997, Vice Chairman of Cassidy &
Associates; from 1989 to 1996, Senior Vice President
of RJR Nabisco, Inc.; from 1988 to 1989, White House
Deputy Chief of Staff.
- -----------------------------------------------------------------------------------------------------------------------
Robert E. Richardson (58) Trustee Retired; from 1990 to 1999, Vice President,
20 Auger Drive Broker/Dealer Department, Mellon Bank, N.A.
Suffern, NY 10901
- -----------------------------------------------------------------------------------------------------------------------
Robert Steinberg (54) * Trustee Senior Managing Director of Bear Stearns and
245 Park Avenue Co-Director of its Risk Arbitrage Department;
New York, NY 10167 Chairman of Bear Stearns International Credit
Committee; Director of The Bear Stearns Companies Inc.
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
<TABLE>
<CAPTION>
TRUSTEES AND OFFICERS
- ----------------------------------------------------------------------------------------------------------------------
Name, (age) and address Position with Trust Principal Occupation
- -----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Alan J. Dixon (71) * Advisory Since 1993, Partner, Bryan Cave (St. Louis law firm);
7535 Claymont Court, Apt. #2 Trustee from 1981 to 1992, United States Senator from
Belleville, IL 62223 Illinois.
- -----------------------------------------------------------------------------------------------------------------------
Barry Sommers (31) Executive Since 1997, Managing Director and Head of Marketing
575 Lexington Avenue Vice President and Sales for the Trust; from 1995 to 1997, Vice
New York, NY 10022 President, Mutual Fund Sales, Goldman, Sachs & Co.
- -----------------------------------------------------------------------------------------------------------------------
Stephen A. Bornstein (57) Vice Managing Director of Bear Stearns, Legal Department;
575 Lexington Avenue President and since 1997, General Counsel, BSAM.
New York, NY 10022 Secretary
- -----------------------------------------------------------------------------------------------------------------------
Frank J. Maresca (41) Vice Since 1997, Managing Director of Bear Stearns;
575 Lexington Avenue President and Associate Director prior thereto; since 1997, Chief
New York, NY 10022 Treasurer Executive Officer and President of BSFM; Executive
Vice President prior thereto.
- -----------------------------------------------------------------------------------------------------------------------
Vincent L. Pereira (34) Assistant Since 1999, Managing Director of Bear Stearns;
575 Lexington Avenue Treasurer Associate Director prior thereto; since 1997,
New York, NY 10022 Executive Vice President, Treasurer and Secretary of
BSFM; Vice President of BSFM prior thereto.
- -----------------------------------------------------------------------------------------------------------------------
</TABLE>
Prior to March 31, 2000, the Trust paid its Trustees and Advisory
Trustee who are not employees of BSAM or its affiliates an annual retainer of
$10,000 and a per meeting fee of $500 and reimbursed them for their expenses.
The Trust does not compensate its officers. The following table shows the
aggregate amount of compensation paid to each Trustee by the Trust for the
fiscal year ended March 31, 2000.
<TABLE>
<CAPTION>
TRUSTEE COMPENSATION
(3)
(2) Pension or (4) (5)
Aggregate Retirement Benefits Estimated Annual Total Compensation
(1) Compensation Accrued as Part of Benefits from from the Trust Paid
Name of Board Member from Trust * Trust's Expenses Retirement to Board Members
-------------------- ------------ ---------------- ---------- ----------------
<S> <C> <C> <C> <C>
Peter M. Bren $10,500 None None $10,500
Alan J. Dixon $12,000 None None $12,000
Doni L. Fordyce None None None None
John S. Levy ** $ 500 None None $ 500
John R. McKernan, Jr. *** $12,000 None None $12,000
Michael Minikes None None None None
M.B. Oglesby, Jr. $12,000 None None $12,000
Robert E. Richardson ** $ 500 None None $ 500
Robert M. Steinberg + None None None None
</TABLE>
49
<PAGE>
* Amount does not include reimbursed expenses for attending Board meetings.
** Messrs. Levy and Richardson commenced service on the Board as of February
7, 2000.
*** Mr. McKernan resigned from the Board effective April 17, 2000.
+ Mr. Steinberg commenced service on the Board as of April 17, 2000.
Effective April 1, 2000, the Trust pays its Trustees and Advisory
Trustees who are not employees of BSAM or its affiliates an annual retainer of
$12,500, $1,000 per in-person meeting, $750 per telephone meeting, $500 per
Audit Committee meeting (whether in-person or by telephone), and will reimburse
them for their expenses.
Board members and officers of the Trust, as a group, owned less than
1% of any Portfolio's shares outstanding on June 30, 2000.
The Board maintains an Audit Committee, whose members currently are
Messrs. Bren (Chairman), Levy and Oglesby. The function of the Audit Committee
is to recommend independent auditors and monitor accounting and financial
matters.
For so long as the Plan described in the section entitled "Management
Arrangements-Distribution Plans" remains in effect, the Trustees who are not
"interested persons" of the Trust, as defined in the 1940 Act, will be selected
and nominated by the Trustees who are not "interested persons" of the Trust.
The Board has adopted a retirement policy that (i) requires a Trustee to retire
before reaching the age of 75 and (ii) prohibits a Trustee who has reached the
age of 72 from standing for re-election to the Board.
No meetings of shareholders of the Trust 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 Trust may remove a Trustee through a
declaration in writing or by vote cast in person or by proxy at a meeting called
for that purpose. Under the Trust'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
Trust's outstanding shares.
MANAGEMENT ARRANGEMENTS
The following information supplements and should be read in
conjunction with the section in the Prospectus entitled "Management of the
Portfolios." Information in this section relating to fees and expenses paid by
the EMD Portfolio prior to July 29, 1999 represents amounts paid by the
Portfolio's predecessor, the Emerging Markets Debt Portfolio, a series of Bear
Stearns Investment Trust, another investment company that was managed by BSAM
("BSIT").
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 Trust and other affiliated and non-affiliated
investment companies.
S&P STARS Portfolio. Prior to June 25, 1997, the Portfolio invested
-------------------
all of its assets into the S&P STARS Master Series of S&P STARS Fund (the
"Master Series"), rather than directly in a
50
<PAGE>
portfolio of securities in an arrangement typically referred to as a
"master-feeder" structure. Active portfolio management was performed at the
Master Series level and BSFM was retained by the Master Series rather than the
Portfolio. At a meeting held on June 18, 1997, a majority of the shareholders of
the Portfolio approved an investment advisory contract between BSAM and the
Portfolio and BSAM began active management of the Portfolio's investments.
Historical information provided below for periods prior to June 25, 1997
pertaining to items such as advisory fees, portfolio turnover, and brokerage
expenses reflects those items as incurred by the Master Series.
Investment Advisory Agreement. BSAM provides investment advisory
-----------------------------
services to each Portfolio pursuant to an Amended and Restated Investment
Advisory Agreement with the Trust approved by a majority of each Portfolio's
shareholders on April 17, 2000. The Advisory Agreement has an initial term of
two years from the date of execution and will continue automatically for
successive annual periods ending on April 17th of each year, provided such
continuance is specifically approved at least annually by (i) the Board or (ii)
the vote of a majority (as defined in the 1940 Act) of the Portfolio's
outstanding voting securities, provided that in either event the continuance
also is approved by a majority of the Trustees who are not "interested persons"
(as defined in the 1940 Act) of the Trust or BSAM, by vote cast in person at a
meeting called for the purpose of voting on such approval. The Advisory
Agreement is terminable, as to a Portfolio, without penalty, on 60 days' notice,
by the Board 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,
the Advisory 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,
Portfolio Manager and Senior Managing Director; Doni L. Fordyce, Director, Chief
Operating Officer, Executive Vice President and Senior Managing Director;
Stephen A. Bornstein, General Counsel, Executive Vice President and Managing
Director; and Warren J. Spector and Robert M. Steinberg, Directors.
The following factors characterize BSAM's overall investment
operations:
. disciplined fundamental analysis augmented by identifying catalysts
for improved financial results;
. first-hand knowledge of company management;
. focus on long-term market efficiency and timeliness; not timing;
. active portfolio management with disciplined sell strategy; and
. direct access to Bear Stearns' Equity Research Department, whose
analysts cover more than 1,100 companies in roughly 100 industries
around the world.
Portfolio Managers. 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.
Advisory Fees. The following table shows the monthly fees that the
Trust has agreed to pay BSAM for advisory services to the Portfolios, at the
indicated annual percentage of the value of a Portfolio's average daily net
assets.
51
<PAGE>
Advisory Fee
- ------------------------------------------------------------------------------
Money Market Portfolio 0.20%
- ------------------------------------------------------------------------------
Income Portfolio 0.45%
- ------------------------------------------------------------------------------
High Yield Portfolio 0.60%
- ------------------------------------------------------------------------------
EMD Portfolio 1.00% of assets up to $50 million, 0.85% of
assets between $50 million and $100 million
and 0.55% of assets above $100 million
- ------------------------------------------------------------------------------
S&P STARS Portfolio 0.75%
- ------------------------------------------------------------------------------
Focus List Portfolio 0.65%
- ------------------------------------------------------------------------------
Large Cap Portfolio 0.75%
- ------------------------------------------------------------------------------
Small Cap Portfolio 0.75%
- ------------------------------------------------------------------------------
Insiders Select Fund 1.00%
- ------------------------------------------------------------------------------
Balanced Portfolio 0.65%
- ------------------------------------------------------------------------------
International Equity Portfolio 1.00%
- ------------------------------------------------------------------------------
Insiders Select Fund. The monthly fee that the Insiders Select Fund
will pay BSAM will be adjusted monthly if the Portfolio's performance
outperforms or underperforms the S&P MidCap 400 Index. This adjustment may
increase or decrease the total advisory fee payable to BSAM by an annual rate of
up to 0.50% of the value of the Portfolio's average daily net assets. The
following table details this adjustment.
<TABLE>
<CAPTION>
INSIDERS SELECT FULCRUM FEE SCHEDULE
- -------------------------------------------------------------------------------------------------------------------------
Percentage Point Difference Between Designated Class Performance Basic Fee Performance Total Fee
(Net of Expenses Including Advisory Fees) and (%) Adjustment Rate (%)
Percentage Change in the S&P MidCap 400 Index (%)
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
+3.00 percentage points or more 1.00% 0.50% 1.50%
- -------------------------------------------------------------------------------------------------------------------------
+2.75 percentage points or more but less than + 3.00 percentage points 1.00% 0.40% 1.40%
- -------------------------------------------------------------------------------------------------------------------------
+2.50 percentage points or more but less than + 2.75 percentage points 1.00% 0.30% 1.30%
- -------------------------------------------------------------------------------------------------------------------------
+2.25 percentage points or more but less than + 2.50 percentage points 1.00% 0.20% 1.20%
- -------------------------------------------------------------------------------------------------------------------------
+2.00 percentage points or more but less than + 2.25 percentage points 1.00% 0.10% 1.10%
- -------------------------------------------------------------------------------------------------------------------------
Less than + 2.00 percentage points but more than -2.00 percentage points 1.00% 0% 1.00%
- -------------------------------------------------------------------------------------------------------------------------
-2.00 percentage points or less but more than -2.25 percentage points 1.00% -0.10% 0.90%
-------------------------------------------------------------------------------------------------------------------------
-2.25 percentage points or less but more than -2.50 percentage points 1.00% -0.20% 0.80%
-------------------------------------------------------------------------------------------------------------------------
-2.50 percentage points or less but more than -2.75 percentage points 1.00% -0.30% 0.70%
-------------------------------------------------------------------------------------------------------------------------
-2.75 percentage points or less but more than -3.00 percentage points 1.00% -0.40% 0.60%
-------------------------------------------------------------------------------------------------------------------------
-3.00 percentage points or less 1.00% -0.50% 0.50%
-------------------------------------------------------------------------------------------------------------------------
</TABLE>
52
<PAGE>
The following table shows the investment advisory fees that the
Portfolios paid to BSAM and the amounts that BSAM waived for the last three
fiscal years ended March 31.
<TABLE>
<CAPTION>
ADVISORY FEES PAID TO BSAM
- ------------------------------------------------------------------------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------
Paid Waived Paid Waived Paid Waived
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Money Market $ 244,099 $ 937,253 $ 33,827 $400,797 $ 0 $ 120,582*
- ------------------------------------------------------------------------------------------------------------------------------
Income $ 0 $ 58,835 $ 0 $ 50,882 $ 0 $ 91,715
- ------------------------------------------------------------------------------------------------------------------------------
High Yield $ 48,217 $ 601,201 $ 25,136 $416,687 $ 0 $ 28,723**
- ------------------------------------------------------------------------------------------------------------------------------
EMD $ 94,451 $ 297,720 $ 88,623 $335,209 $208,721 $ 227,031+
- ------------------------------------------------------------------------------------------------------------------------------
S&P STARS $4,111,635 $1,311,869 $1,291,152 $716,763 $617,316 $ 645,637
- ------------------------------------------------------------------------------------------------------------------------------
Insiders $ 0 $ 229,835 $ 759 $321,688 $ 0 $ 157,031
Select Fund
- ------------------------------------------------------------------------------------------------------------------------------
Large Cap $ 0 $ 148,333 $ 0 $165,850 $ 0 $ 140,641
- ------------------------------------------------------------------------------------------------------------------------------
Small Cap $ 33,542 $ 417,207 $ 67,550 $400,694 $ 0 $ 425,409
- ------------------------------------------------------------------------------------------------------------------------------
Focus List $ 0 $ 152,064 $ 0 $ 63,550 $ 0 $ 6,748***
- ------------------------------------------------------------------------------------------------------------------------------
Balanced $ 0 $ 122,347 $ 0 $101,976 $ 0 $ 12,178***
- ------------------------------------------------------------------------------------------------------------------------------
International $ 0 $ 265,757 $ 0 $114,148 $ 0 $ 14,726***
Equity
- ------------------------------------------------------------------------------------------------------------------------------
</TABLE>
* From July 14, 1997 (commencement of investment operations) to March 31,
1998.
** From January 2, 1998 (commencement of investment operations) to March
31, 1998.
*** From December 29, 1997 (commencement of investment operations) to March
31, 1998.
+ This amount includes an administration fee that BSAM paid to BSFM.
In addition, BSAM reimbursed the following amounts for the last three
fiscal years ended March 31, in order to maintain applicable voluntary expense
limitations.
EXPENSES REIMBURSED BY BSAM
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Money Market $ 85,804 $142,863 $ 191,174*
- -------------------------------------------------------------------------------
Income $350,343 $299,061 $ 275,119
- -------------------------------------------------------------------------------
High Yield $ 27,552 $121,391 $ 41,870**
- -------------------------------------------------------------------------------
EMD $ 83,010 $137,134 $ 158,832
- -------------------------------------------------------------------------------
Insiders Select Fund $ 98,749 $ 42,908 $ 164,325
- -------------------------------------------------------------------------------
Large Cap $205,073 $157,111 $ 185,275
- -------------------------------------------------------------------------------
Small Cap $ 28,144 $ 28,865 $ 20,648
- -------------------------------------------------------------------------------
Focus List $158,778 $218,241 $ 46,255***
- -------------------------------------------------------------------------------
</TABLE>
53
<PAGE>
EXPENSES REIMBURSED BY BSAM
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------
<S> <C> <C> <C>
Balanced $293,853 $224,243 $ 46,910***
- -------------------------------------------------------------------------------
International Equity $ 94,639 $157,011 $ 44,515***
- -------------------------------------------------------------------------------
</TABLE>
* From July 14, 1997 (commencement of investment operations) to March 31,
1998.
** From January 2, 1998 (commencement of investment operations) to March 31,
1998.
*** From December 29, 1997 (commencement of investment operations) to March 31,
1998.
Investment Sub-Advisory Agreement. Marvin & Palmer Associates, Inc.
---------------------------------
(the "Sub-Adviser") provides investment advisory services to the International
Equity Portfolio pursuant to an Amended and Restated Investment Sub-Advisory
Agreement with BSAM approved by a majority of the Portfolio's shareholders on
April 17, 2000. The Sub-Advisory Agreement has an initial term of two years from
the date of execution and will continue automatically for successive annual
periods ending on April 17th of each year, provided such continuance is
specifically approved at least annually by (i) the Board or (ii) a vote of a
majority of the Portfolio's outstanding voting securities (as defined in the
1940 Act), provided that in either case its continuance also is approved by a
majority of the Trustees who are not "interested persons" (as defined in the
1940 Act) of the Trust, BSAM or the Sub-Adviser, by vote cast in person at a
meeting called for the purpose of voting on such approval. The Sub- Advisory
Agreement may be terminated without penalty, (i) by BSAM upon 60 days' notice to
the Sub-Adviser, (ii) by the Board or by vote of the holders of a majority of
the Portfolio's shares upon 60 days' notice to the Sub-Adviser, or (iii) by the
Sub-Adviser upon not less than 90 days' notice to the Trust and BSAM. The
Sub-Advisory Agreement will terminate automatically in the event of its
assignment (as defined in the 1940 Act). As compensation for the Sub- Adviser's
services, BSAM has agreed to pay the Sub-Adviser a monthly fee calculated on an
annual basis equal to 0.20% of the Portfolio's total average daily net assets to
the extent the Portfolio's average daily net assets are in excess of $25 million
and below $50 million at the relevant month end, 0.45% of the Portfolio's total
average daily net assets to the extent the Portfolio's average daily net assets
are in excess of $50 million and below $65 million at the relevant month end,
and 0.60% of the Portfolio's total average daily net assets to the extent the
Portfolio's average daily net assets are in excess of $65 million at the
relevant month end.
On September 30, 1999, the SEC entered a Consent Order in In the
------
Matter of Marvin & Palmer Associates, Inc. et al. (Admin. Proc. File No.
- ------------------------------------------------
3-10072). Without admitting or denying the allegations, the Sub-Adviser and
David F. Marvin, its Chairman and Chief Executive Officer, consented to the
Order in which the SEC found that the Sub-Adviser, Mr. Marvin and two unrelated
parties violated, or aided in the violation of Sections 206(1), 206(2) and 207
of the Investment Advisers Act of 1940, as amended, in connection with the
alleged failure of the Sub-Adviser to properly disclose a soft dollar
arrangement with a third party. The Consent Order, among other things, censured
the Sub-Adviser and Mr. Marvin and ordered the Sub-Adviser to pay disgorgement
and prejudgment interest in the aggregate amount of $976,980. The Sub-Adviser
and Mr. Marvin were ordered to pay civil money penalties in the amounts of
$50,000 and $25,000, respectively. Neither the Sub-Adviser nor Mr. Marvin is
prohibited from acting as, or being associated with, an investment adviser.
Administration Agreement. BSFM provides certain administrative
------------------------
services to the Trust pursuant to the Administration Agreement with the Trust
dated February 22, 1995, as revised April 11, 1995, June 2, 1997, September 8,
1997, February 4, 1998 and July 29, 1999. The Administration Agreement was last
approved as of February 7, 2000 and thereafter will be subject to annual
approval by (i) the Board or (ii) vote of a majority of the outstanding voting
securities (as defined in the 1940 Act) of
54
<PAGE>
the Portfolio, provided that in either event its continuance also is approved by
a majority of the Trustees who are not "interested persons" (as defined in the
1940 Act) of the Trust or BSFM, by vote cast in person at a meeting called for
the purpose of voting on such approval. The Administration Agreement may be
terminated without penalty on 60 days' notice by the Board or by vote of the
holders of a majority of the Portfolio's shares or, upon not less than 90 days'
notice, by BSFM. As to each Portfolio, the Administration Agreement will
terminate automatically in the event of its assignment (as defined in the 1940
Act).
For administrative services, the Trust has agreed to pay BSFM a
monthly fee, on behalf of each Portfolio (other than the Money Market
Portfolio), equal to an annual rate of 0.15% of the Portfolio's average daily
net assets up to $1 billion, 0.12% of the next $1 billion, 0.10% of the next $3
billion and 0.08% of net assets above $5 billion, subject to a minimum annual
fee of $150,000 per Portfolio (other than the Money Market Portfolio). The Trust
has agreed to pay BSFM a monthly fee at the annual rate of 0.05% of the average
daily net assets of the Money Market Portfolio. The following table shows the
administration fees that the Portfolios paid to BSFM for the last three fiscal
years ended March 31.
<TABLE>
<CAPTION>
ADMINISTRATION FEES PAID TO BSFM
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
2000 1999 1998
- ---------------------------------------------------------------------------------------------------------
Money Market $ 295,338 $108,656 $ 30,167 *
- ---------------------------------------------------------------------------------------------------------
Income $ 19,612 $ 16,960 $ 30,572
- ---------------------------------------------------------------------------------------------------------
High Yield $ 162,354 $110,456 $ 7,181 **
- ---------------------------------------------------------------------------------------------------------
EMD+ $ 52,054 $ 0 $ 0
- ---------------------------------------------------------------------------------------------------------
S&P STARS $1,084,891 $401,582 $252,557
- ---------------------------------------------------------------------------------------------------------
Insiders Select Fund $ 60,652 $ 68,666 $ 35,492
- ---------------------------------------------------------------------------------------------------------
Large Cap $ 29,667 $ 33,079 $ 28,128
- ---------------------------------------------------------------------------------------------------------
Small Cap $ 95,666 $ 99,413 $ 85,085
- ---------------------------------------------------------------------------------------------------------
Focus List $ 35,090 $ 14,665 $ 1,557 ***
- ---------------------------------------------------------------------------------------------------------
Balanced $ 28,234 $ 23,533 $ 2,810 ***
- ---------------------------------------------------------------------------------------------------------
International Equity $ 48,520 $ 17,122 $ 2,209 ***
- ---------------------------------------------------------------------------------------------------------
</TABLE>
* From July 14, 1997 (commencement of investment operations) to March 31,
1998.
** From January 2, 1998 (commencement of investment operations) to March 31,
1998.
*** From December 29, 1997 (commencement of investment operations) to March 31,
1998.
+ Prior to July 29, 1999, BSAM paid BSFM administration fees from BSAM's
management fee.
Administrative Services Agreement. PFPC provides certain
---------------------------------
administrative services to the Portfolios pursuant to the Administrative
Services Agreement with the Trust dated February 22, 1995, as revised September
8, 1997 and July 29, 1999. The Administrative Services Agreement may be
terminated upon 60 days' notice by the Trust 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 Trust 30 days' notice; (ii) the
delegate (or assignee) agrees with PFPC and the Trust to comply with all
relevant provisions of the 1940 Act; and (iii) PFPC and such delegate (or
assignee) promptly provide information requested by the Trust in connection with
such delegation.
55
<PAGE>
For administrative and accounting services, the Trust has agreed to
pay PFPC a monthly fee, on behalf of each Portfolio (other than the Money Market
Portfolio), equal to an annual rate of 0.10% of the Portfolio's average daily
net assets up to $200 million, 0.075% of the next $200 million, 0.05% of the
next $200 million and 0.03% of net assets above $600 million, subject to a
minimum annual fee of $150,000 per Portfolio (other than the Money Market
Portfolio). The Trust has agreed to pay PFPC a monthly fee, on behalf of the
Money Market Portfolio, equal to an annual rate of 0.075% of the Portfolio's
average daily net assets up to $150 million, 0.04% of the next $150 million,
0.02% of the next $300 million and 0.0125% of net assets above $600 million,
subject to a minimum monthly fee of $6,250. The following table shows the
administrative services fees that the Portfolios paid to PFPC for the last three
fiscal years ended March 31.
<TABLE>
<CAPTION>
ADMINISTRATION FEES PAID TO PFPC
- ----------------------------------------------------------------------------------------------------
2000 1999 1998
- ----------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Money Market $241,645 $139,740 $ 39,813*
- ----------------------------------------------------------------------------------------------------
Income $ 98,573 $103,612 $ 98,944
- ----------------------------------------------------------------------------------------------------
High Yield $137,872 $105,728 $ 5,468**
- ----------------------------------------------------------------------------------------------------
EMD $ 92,010 $ 92,305 $ 80,121
- ----------------------------------------------------------------------------------------------------
S&P STARS $496,050 $256,593 $ 197,706
- ----------------------------------------------------------------------------------------------------
Insiders Select Fund $127,821 $127,397 $ 123,259
- ----------------------------------------------------------------------------------------------------
Large Cap $ 91,804 $100,173 $ 100,107
- ----------------------------------------------------------------------------------------------------
Small Cap $145,164 $147,784 $ 134,255
- ----------------------------------------------------------------------------------------------------
Focus List $ 90,839 $ 50,847 $ 5,214***
- ----------------------------------------------------------------------------------------------------
Balanced $108,840 $ 64,618 $ 5,367***
- ----------------------------------------------------------------------------------------------------
International Equity $108,251 $ 55,768 $ 5,215***
- ----------------------------------------------------------------------------------------------------
</TABLE>
* From July 14, 1997 (commencement of investment operations) to March 31,
1998.
** From January 2, 1998 (commencement of investment operations) to March 31,
1998.
*** From December 29, 1997 (commencement of investment operations) to March 31,
1998.
Distribution Plans. Rule 12b-1 adopted by the SEC under Section 12 of
------------------
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. On April 17, 2000, the Trust's shareholders approved
amended and restated distribution plans with respect to Class A, Class B and
Class C shares (the "Distribution Plans"). The Board believes that there is a
reasonable likelihood that the Distribution Plans will benefit each Portfolio
and the holders of its Class A, Class B and Class C shares.
The Board reviews a quarterly report of the amounts expended under the
Distribution Plans, and the purposes for which such expenditures were incurred.
In addition, each 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 affected shareholders and that
other material amendments of the Plan must be approved by the Board, and by the
Trustees who are neither "interested persons" (as defined in the 1940 Act) of
the Trust 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
Trust is required by a SEC rule to obtain the approval of Class B as
56
<PAGE>
well as Class A shareholders for a proposed amendment to each 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. Each
Distribution Plan and related agreement is subject to annual approval by such
vote cast in person at a meeting called for the purpose of voting on such Plan.
Each Distribution Plan may be terminated at any time 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
may be terminated 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 in the event of its assignment (as
defined in the 1940 Act). Each Plan provides that to the extent that any
payments made by Bear Stearns, BSFM, BSAM or any sub-adviser, directly or
through an affiliate (in each case, from its own resources), should be deemed to
be indirect financing of any activity primarily intended to result in the sale
of Portfolio shares within the context of Rule 12b-1, then such payments shall
be deemed to be authorized by the Plan.
The following tables show the amounts that each class of shares of
each Portfolio paid for the fiscal year ended March 31, 2000 under the relevant
Distribution Plan, including (i) amounts paid to broker-dealers, and (ii)
amounts retained by Bear Stearns for commissions it advanced to dealers for fund
share sales, and other distribution expenses including advertising, printing,
mailing prospectuses to prospective shareholders, compensation to sales
personnel, and interest, carrying, or other financing charges. These tables
include amounts paid for personal services rendered to shareholders of the
Portfolios.
<TABLE>
<CAPTION>
RULE 12b-1 PAYMENTS
Class A
- --------------------------------------------------------------------------------------
Total Payments Broker-dealers Distributor
- --------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income $ 16,785 $ 9,709 $ 7,076
- --------------------------------------------------------------------------------------
High Yield $ 200,757 $ 83,549 $ 117,208
- --------------------------------------------------------------------------------------
EMD $ 107,258 $ 81,406 $ 25,852
- --------------------------------------------------------------------------------------
S&P STARS $1,728,411 $701,844 $1,026,567
- --------------------------------------------------------------------------------------
Insiders Select Fund $ 107,664 $ 71,237 $ 36,427
- --------------------------------------------------------------------------------------
Large Cap $ 45,082 $ 28,990 $ 16,092
- --------------------------------------------------------------------------------------
Small Cap $ 103,526 $ 65,951 $ 37,575
- --------------------------------------------------------------------------------------
Focus List $ 60,899 $ 14,096 $ 46,803
- --------------------------------------------------------------------------------------
Balanced $ 22,544 $ 7,545 $ 14,999
- --------------------------------------------------------------------------------------
International Equity $ 101,146 $ 18,325 $ 82,821
- --------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
RULE 12b-1 PAYMENTS
Class B
- -------------------------------------------------------------------------------------
Total Payments Broker-dealers Distributor
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income $ 19,239 $ 1,467 $ 17,772
- -------------------------------------------------------------------------------------
High Yield $ 257,571 $29,968 $ 227,603
- -------------------------------------------------------------------------------------
EMD $ 17,496 $ 2,395 $ 15,101
- -------------------------------------------------------------------------------------
</TABLE>
57
<PAGE>
<TABLE>
<CAPTION>
RULE 12b-1 PAYMENTS
Class B
- -------------------------------------------------------------------------------------
Total Payments Broker-dealers Distributor
- -------------------------------------------------------------------------------------
<S> <C> <C> <C>
S&P STARS $1,298,365 $60,256 $1,238,109
- -------------------------------------------------------------------------------------
Insiders Select Fund $ 75,266 $11,807 $ 63,459
- -------------------------------------------------------------------------------------
Large Cap $ 17,711 $ 2,320 $ 15,391
- -------------------------------------------------------------------------------------
Small Cap $ 33,413 $ 4,499 $ 28,914
- -------------------------------------------------------------------------------------
Focus List $ 62,809 $ 7,975 $ 54,834
- -------------------------------------------------------------------------------------
Balanced $ 20,560 $ 3,370 $ 17,190
- -------------------------------------------------------------------------------------
International Equity $ 58,422 $ 7,507 $ 50,915
- -------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
RULE 12b-1 PAYMENTS
Class C
- -----------------------------------------------------------------------------------------------
Total Payments Broker-dealers Distributor
- -----------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income $ 20,394 $ 14,011 $ 6,383
- -----------------------------------------------------------------------------------------------
High Yield $ 250,616 $112,557 $138,060
- ------------------------------------------------------------------------------------------
EMD $ 23,447 $ 18,060 $ 5,387
- ------------------------------------------------------------------------------------------
S&P STARS $1,623,394 $845,923 $777,471
- ------------------------------------------------------------------------------------------
Insiders Select Fund $ 104,263 $ 90,468 $ 13,795
- ------------------------------------------------------------------------------------------
Large Cap $ 47,396 $ 40,177 $ 7,219
- ------------------------------------------------------------------------------------------
Small Cap $ 122,343 $100,379 $ 21,964
- ------------------------------------------------------------------------------------------
Focus List $ 49,326 $ 28,207 $ 21,119
- ------------------------------------------------------------------------------------------
Balanced $ 15,911 $ 9,786 $ 6,125
- ------------------------------------------------------------------------------------------
International Equity $ 62,755 $ 35,740 $ 27,015
- ------------------------------------------------------------------------------------------
</TABLE>
Shareholder Servicing Plan. The Trust has adopted a shareholder
--------------------------
servicing plan on behalf of Class A, Class B and Class C shares of the
Portfolios (the "Shareholder Servicing Plan"). In accordance with the
Shareholder Servicing Plan, the Trust may enter into agreements under which a
Portfolio pays fees of up to 0.25% of the average daily net assets of a share
Class for expenses incurred in connection with the personal service and
maintenance of Portfolio shareholder accounts, 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.
Expenses. The Trust bears all expenses incurred in its operation,
--------
except to the extent that BSAM specifically assumes them. The Trust bears the
following expenses, among others: 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, SEC fees, state Blue Sky
qualification fees, advisory, administrative and Trust 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 Trust'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
58
<PAGE>
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 Trust are
allocated among the Portfolios on the basis determined by the Board, including,
but not limited to, proportionately in relation to the net assets of each
Portfolio.
Expense Limitations. BSAM has agreed in writing to limit the expenses
-------------------
of each Portfolio to the amounts indicated in the Prospectus until July 31,
2001. These limits do not include any taxes, brokerage commissions, interest on
borrowings and extraordinary expenses.
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 Prospectus entitled "How to Buy Shares" and
"How to Sell Shares." Information in this section relating to sales and
redemption charges retained by Bear Stearns with respect to the EMD Portfolio
prior to July 29, 1999 represent amounts related to sales and redemptions of the
Portfolio's predecessor, the Emerging Markets Debt Portfolio, a series of BSIT.
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, February 4, 1998 and July 29, 1999, which is renewable
annually. From time to time, Bear Stearns or its affiliates may pay, from its
own resources, to broker-dealers or other financial institutions a fee related
to the sale of the Portfolios' shares or the maintenance of shareholder accounts
related to such shares.
The following table shows the approximate amounts that Bear Stearns
retained from front end sales loads ("FESL") on Class A shares and on contingent
deferred sales charges ("CDSC") on Class A, B and C shares for the three fiscal
years ended March 31. In some states, banks or other institutions effecting
transactions in Portfolio shares may be required to register as dealers pursuant
to state law.
59
<PAGE>
SALES LOADS RETAINED BY BEAR STEARNS
<TABLE>
<CAPTION>
- -------------------------------------------------------------------------------------------
2000 1999 1998
- -------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Income
- ----------
FESL -- A $ 26,800 $ 35,200 $ 11,400
CDSC -- B $ 14,400 $ 600 $ 0
CDSC -- C $ 200 $ 2,000 $ 100
- -------------------------------------------------------------------------------------------
High Yield
- ----------
FESL -- A $ 235,700 $ 525,500 $ 155,700*
CDSC -- A $ 20,900 $ 9,000 $ 0
CDSC -- B $ 173,100 $ 58,800 $ 0
CDSC -- C $ 20,400 $ 33,700 $ 0
- -------------------------------------------------------------------------------------------
EMD
- ----
FESL -- A $ 49,800 $ 46,300 $ 88,900
CDSC -- B $ 17,000 $ 13,000 $ 0
CDSC -- C $ 100 $ 2,200 $ 1,900
- -------------------------------------------------------------------------------------------
S&P STARS
- ---------
FESL -- A $6,677,300 $2,061,000 $1,022,800
CDSC -- B $ 352,600 $ 68,300 $ 0
CDSC -- C $ 59,800 $ 24,500 $ 25,800
- -------------------------------------------------------------------------------------------
Insiders Select Fund
- --------------------
FESL -- A $ 71,400 $ 389,100 $ 236,000
CDSC -- B $ 91,900 $ 69,800 $ 0
CDSC -- C $ 2,900 $ 14,400 $ 2,600
Large Cap
- ---------
FESL -- A $ 52,500 $ 86,200 $ 68,300
CDSC -- B $ 12,900 $ 9,000 $ 0
CDSC -- C $ 500 $ 4,500 $ 600
- -------------------------------------------------------------------------------------------
Small Cap
- --------- $ 78,500 $ 165,300 $ 214,800
FESL -- A $ 16,700 $ 14,200 $ 0
CDSC -- B $ 1,700 $ 7,600 $ 4,100
CDSC -- C
- -------------------------------------------------------------------------------------------
Focus List
- ----------
FESL -- A $ 271,400 $ 111,800 $ 71,600**
CDSC -- B $ 41,500 $ 30,300 $ 0
CDSC -- C $ 2,200 $ 700 $ 0
- -------------------------------------------------------------------------------------------
Balanced
- --------
FESL -- A $ 23,600 $ 43,000 $ 32,300**
CDSC -- A $ 300 $ 0 $ 0
CDSC -- B $ 2,600 $ 1,500 $ 0
CDSC -- C $ 200 $ 0 $ 0
- -------------------------------------------------------------------------------------------
International Equity
- --------------------
FESL -- A $ 641,600 $ 92,700 $ 58,100**
CDSC -- B $ 19,900 $ 6,700 $ 0
CDSC -- C $ 4,200 $ 700 $ 0
- -------------------------------------------------------------------------------------------
</TABLE>
60
<PAGE>
* From January 2, 1998 (commencement of investment operations) to March 31,
1998.
** From December 29, 1997 (commencement of investment operations) to March 31,
1998.
Purchase Order Delays. The effective date of a purchase order may be
---------------------
delayed if PFPC, the Portfolios' transfer agent, is unable to process the
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.
-------------------
The sales charge may vary depending on the dollar amount invested in
each Portfolio. The public offering price for Class A shares of each Portfolio
is the NAV of that class plus a sales load, which is imposed in accordance with
the following schedules.
FRONT END SALES LOAD SCHEDULE AND DEALER CONCESSIONS
Fixed Income Funds
<TABLE>
<CAPTION>
TOTAL SALES LOAD
----------------------------------------------
Amount of Transaction As a % of offering As a % of NAV Dealer concessions as
price per share a % of offering price
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $50,000 4.50% 4.71% 4.25%
$50,000 to less than $100,000 4.25 4.44 4.00
$100,000 to less than $250,000 3.25 3.36 3.00
$250,000 to less than $500,000 2.50 2.56 2.25
$500,000 to less than $1,000,000 2.00 2.04 1.75
$1,000,000 to less than $3,000,000* 0.00 0.00 1.25
$3,000,000 to less than $5,000,000 0.00 0.00 0.75
$5,000,000 and above 0.00 0.00 0.50
</TABLE>
Equity Funds
<TABLE>
<CAPTION>
TOTAL SALES LOAD
----------------------------------------------
Amount of Transaction As a % of offering As a % of NAV Dealer concessions as
price per share a % of offering price
- -------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Less than $50,000 5.50% 5.82% 5.25%
$50,000 to less than $100,000 4.75 4.99 4.25
$100,000 to less than $250,000 3.75 3.90 3.25
$250,000 to less than $500,000 2.75 2.83 2.50
$500,000 to less than $1,000,000 2.00 2.04 1.75
$1,000,000 to less than $3,000,000* 0.00 0.00 1.25
$3,000,000 to less than $5,000,000 0.00 0.00 0.75
$5,000,000 and above 0.00 0.00 0.50
</TABLE>
________
* There is no initial sales charge on purchases of $1,000,000 or more of Class
A shares. However, if an investor purchases Class A shares without an
initial sales charge as part of an investment of at least $1,000,000 and
redeems those shares up to one year after the date of purchase, a CDSC of
1.00% will be imposed at the time of redemption. Letter of Intent and Right
of Accumulation apply to such purchases of Class A shares.
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<PAGE>
The dealer concession may be changed from time to time but will remain
the same for all dealers. From time to time, Bear Stearns may make or allow
additional payments or promotional incentives to dealers that sell Class A
shares. In some instances, these incentives may be offered only to certain
dealers who have sold or may sell significant amounts of Class A shares. Dealers
may receive a larger percentage of the sales load from Bear Stearns than they
receive for selling most other funds.
As described in the Prospectus, an investor may buy Class A shares of
a Portfolio at NAV if the purchase is (a) for $1,000,000 or more or (b) made
within 60 days of selling a mutual fund that charges a sales load or is subject
to a CDSC and not distributed by Bear Stearns. In connection with such
purchases, Bear Stearns will offer to pay dealers, from its own resources, up to
1.25% of the amount purchased. However, Bear Stearns will not pay this amount if
the investor is a managed account over which BSAM has investment discretion, or
if BSAM is responsible for the asset allocation with respect to such managed
account.
In addition, Class A shares of a Portfolio may be purchased at NAV by
the following customers of a broker that operates a master account for
purchasing and redeeming, and otherwise provides shareholder services in respect
of Portfolio shares pursuant to agreements with the Trust or Bear Stearns: (i)
investment advisers and financial planners who place trades for their own
accounts or for the accounts of their clients and who charge a management,
consulting or other fee, (ii) clients of such investment advisers and financial
planners if such clients place trades through accounts linked to master accounts
of such investment advisers or financial planners on the books and records of
such broker, and (iii) retirement and deferred compensation plans, and trusts
used to fund such plans, including, but not limited to, plans or trusts defined
in sections 401(a), 403(b) or 457 of the Code, and "rabbi trusts," provided, in
each case, the purchase transaction is effected through such broker. The broker
may charge a fee for transactions in Portfolio shares. In connection with such
purchases, Bear Stearns will offer to pay dealers, from its own resources, the
following percentages of the amount purchased: 1.25% of purchases up to
$2,999,999; 0.75% of purchases between $3,000,000 and $4,999,999; and 0.50% of
purchases above $5,000,000.
Set forth below is an example of the method of computing the offering
price per share 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 NAV of
the Class A shares on March 31, 2000.
COMPUTATION OF OFFERING PRICE
Fixed Income Funds
- ------------------------------------------------------------
High
Income Yield EMD
- -----------------------------------------------------------
NAV $11.53 $ 9.78 $10.58
- -----------------------------------------------------------
Sales Charge -
4.50% (4.71% of 0.54 0.46 0.50
NAV)
- -----------------------------------------------------------
Offering Price $12.07 $10.24 $11.08
- -----------------------------------------------------------
62
<PAGE>
Equity Funds
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------------------------
Insiders
S&P STARS Select Large Cap Small Cap Focus List Balanced Int'l Equity
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
NAV $36.42 $16.90 $16.71 $23.10 $21.21 $12.55 $27.84
- --------------------------------------------------------------------------------------------------------------------
Sales Charge -
5.50% (5.82% of 2.12 0.98 0.97 1.34 1.23 0.73 1.62
NAV)
- --------------------------------------------------------------------------------------------------------------------
Offering Price $38.54 $17.88 $17.68 $24.44 $22.44 $13.28 $29.46
- --------------------------------------------------------------------------------------------------------------------
</TABLE>
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 SEC. In the case of requests for
redemption in excess of such amount, the Board 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 the same manner as the Portfolio is valued. If the
recipient sold such securities, brokerage charges would be incurred.
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 NAV (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 A,
Class B and Class C shares and the dividends payable on these shares will be
reduced by incremental expenses borne solely by that class, including the asset-
based sales charge to which these Classes are subject.
The methodology for calculating the NAV, dividends and distributions
of each Portfolio's Class A, B, C and Y shares recognizes two types of expenses.
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) printing and postage expenses related
to preparing and distributing Portfolio materials, shareholder reports,
prospectuses and proxies to current shareholders of a specific class; (c) SEC
and state registration fees incurred by a specific class; (d) the expense of
administrative personnel and services as required to support the shareholders of
a specific class; (e) litigation or legal expenses relating solely to a specific
class; and (f) Trustees' fees incurred as a result of issues relating to a
specific class. Any expenses of a Portfolio not allocated to a particular class
is allocated to each class of the Portfolio on the basis of the NAV of that
class in relation to the net asset
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<PAGE>
value of the Portfolio. The Adviser, Distributor, Administrator and any other
provider of services to the Trust may waive or reimburse the expenses of a
particular class or classes, as long as such waiver does not result in cross
subsidization between the classes.
None of the instructions described elsewhere in the Prospectus or SAI
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.
Money Market Portfolio. The regulations of the Comptroller of the
----------------------
Currency provide that funds held in a fiduciary capacity by a national bank
approved by the Comptroller to exercise fiduciary powers must be invested in
accordance with the instrument establishing the fiduciary relationship and local
law. The Trust believes that the purchase of Money Market Portfolio shares by
such national banks acting on behalf of their fiduciary accounts is not contrary
to applicable regulations if consistent with the particular account and proper
under the law governing the administration of the account.
DETERMINATION OF NET ASSET VALUE
The following information supplements and should be read in
conjunction with the section in the Prospectus entitled "How to Buy Shares."
A Portfolio's share price, or "NAV" is calculated by dividing the
total assets of the Fund, less all liabilities, by the total number of shares
outstanding. The net asset value is determined as of the close of the New York
Stock Exchange (the "Exchange") (generally 4:00 p.m. Eastern time) on each day
that the Exchange is open for trading. Portfolio securities for which market
quotations are readily available (which include those securities listed on
national securities exchanges, as well as those quoted on the NASDAQ Stock
Market) will be valued at the last quoted sales price on the day the valuation
is made. A Portfolio's NAV is calculated separately for each class by dividing
the total value of the assets belonging to the Portfolio attributable to a
class, less the value of any class-specific liabilities charged to the Portfolio
by the total number of the Portfolio's shares of that class outstanding. "Assets
belonging to" a Portfolio consist of the consideration received upon the
issuance of Portfolio shares together with all income, earnings, profits and
proceeds derived from the investment thereof, including any proceeds from the
sale of such investments, any funds or payments derived from any reinvestment of
such proceeds and a portion of any general assets of the Trust not belonging to
a particular Portfolio. Assets belonging to a Portfolio are charged with the
direct liabilities of the Portfolio and with a share of the general liabilities
of the Trust allocated on a daily basis in proportion to the relative net assets
of the Portfolio and the Trust's other portfolios. Determinations made in good
faith and in accordance with generally accepted accounting principles by the
Trust's Board of Trustees as to the allocation of any assets or liabilities with
respect to a Portfolio are conclusive. All cash, receivables and current
payables are carried on a Portfolio's books at their face value.
Short-term debt instruments ("money market securities"). The Money
Market Portfolio uses the amortized cost method of valuation to compute the NAV
of its shares for purposes of sales and redemptions. Under this method, the
Portfolio values each of its portfolio securities at cost on the date of
purchase and thereafter assumes a constant proportionate amortization of any
discount or premium until maturity of the security. As a result, the value of
the portfolio security for purposes of determining NAV normally does not change
in response to fluctuating interest rates. While the amortized cost method seems
to provide certainty in portfolio valuation, it may result in valuations of the
Portfolio's securities that are higher or lower than the market value of such
securities.
64
<PAGE>
In connection with its use of amortized cost valuation, the Money
Market Portfolio limits the dollar-weighted average maturity of its portfolio to
not more than 90 days and does not purchase any instrument with a remaining
maturity of more than thirteen months (397 days) (with certain exceptions). The
Board has also established procedures pursuant to rules promulgated by the SEC
that are intended to stabilize the Portfolio's NAV for purposes of sales and
redemptions at $1.00. Such procedures include the determination, at such
intervals as the Board deems appropriate, of the extent, if any, to which the
Portfolio's NAV calculated by using available market quotations deviates from
$1.00 per share. In the event such deviation exceeds 1/2 of 1%, the Board will
consider promptly what action, if any, should be initiated. If the Board
believes that the amount of any deviation from the Portfolio's $1.00 amortized
cost price per share may result in material dilution or other unfair results to
investors, it will take such steps as it considers appropriate to eliminate or
reduce to the extent reasonably practicable any such dilution or unfair results.
These steps may include selling portfolio instruments prior to maturity to
realize capital gains or losses or shortening the Portfolio's average portfolio
maturity, redeeming shares in kind, reducing or withholding dividends, or
utilizing a net asset value per share determined by using available market
quotations.
Other Portfolios may value short-term instruments (those acquired with
remaining maturities of 60 days or less) at cost, plus or minus any amortized
discount or premium, which approximates market value.
Fixed-income securities. Substantially all fixed-income securities
(including short-term instruments that are not valued using the amortized cost
method) are valued each business day as of the close of regular trading on the
Exchange by one or more independent pricing services (the "Pricing Services")
approved by the Trust's Board of Trustees. When quoted bid prices are readily
available, the Pricing Services generally value fixed-income securities at the
mean of the bid and ask prices, provided that the Pricing Service believes those
prices to reflect the fair market value of the securities. Other instruments
valued by Pricing Services are carried at fair value as determined by the
Pricing Service, based on 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. Pricing
Services may take other factors into consideration in pricing securities,
including institutional size transactions in similar groups of securities as
well as developments related to specific securities. Securities that are not
valued by a Pricing Service are valued at the average of the most recent bid and
asked prices in the market in which such securities 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 securities
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.
Equity securities. Equity securities, including written covered call
options, are valued each business day at the last sale price as of the close of
regular trading on the Exchange by one or more Pricing Services approved by the
Board of Trustees. 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.
Foreign securities. Foreign securities are valued by Pricing Services
at the last quoted sales price, according to the broadest and most
representative market, available at the time the Portfolio is valued. In
determining the Fund's net asset value per share, all assets and liabilities
initially expressed in foreign currencies will be converted into U.S. dollars
using the officially quoted daily exchange rates used by Morgan Stanley Capital
International in calculating various benchmarking indices. This officially
quoted exchange rate may be determined prior to or after the close of a
particular securities market. If such quotations are not available, the rate of
exchange will be determined in accordance with policies
65
<PAGE>
established in good faith by the Board of Trustees. Occasionally, events
affecting the value of foreign securities and such exchange rates occur between
the time at which they are determined and the close of the Exchange. The effect
of those events will not be reflected in a computation of a Portfolio's net
asset value. If events materially affecting the value of such securities or
assets or currency exchange rates occurred during such time period, the
securities or assets would be valued at their fair value as determined in good
faith by or under the direction of the Trust's Board of Trustees. The foreign
currency exchange transactions of a Portfolio conducted on a spot basis will be
valued at the spot rate for purchasing or selling currency prevailing on the
foreign exchange market. Forward currency contracts will be valued at the
current cost of offsetting the contract.
General. Other assets and securities for which no quotations are
readily available or which are restricted as to sale (or resale) are valued by
such methods as the Trust's Board of Trustees deems in good faith to reflect the
fair value. 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 Trust's Board of Trustees, are valued at fair
value as determined in good faith by BSAM's Valuation Committee, pursuant to
procedures approved by the Trust's Board. The Board reviews the method of
valuation quarterly. In making their good faith valuation of restricted
securities, the Valuation Committee 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 (the Board will revise this discount periodically if it
believes that the discount 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 Valuation Committee.
New York Stock Exchange Closings. The holidays (as observed) on which
--------------------------------
the New York Stock Exchange is closed currently are: New Year's Day, Dr. Martin
Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving and Christmas.
TAXES
The following information supplements and should be read in
conjunction with the section in the Prospectus entitled "Dividends,
Distributions and Taxes."
Information set forth in the Prospectus and this SAI that relates to
federal taxation is only a summary of certain key federal tax considerations
generally affecting purchasers of shares of the Portfolios. The following is
only a summary of certain additional tax considerations generally affecting each
Portfolio and its shareholders that are not described in the Prospectus. No
attempt has been made to present a complete explanation of the federal tax
treatment of the Portfolios or the implications to shareholders, and the
discussions here and in each Portfolio's prospectus are not intended as
substitutes for careful tax planning. Accordingly, potential purchasers of
shares of the Portfolios are urged to consult their tax advisers with specific
reference to their own tax circumstances. In addition, the tax discussion in the
Prospectus and this SAI is based on tax law in effect on the date of the
Prospectuses and this SAI; such laws and regulations may be changed by
legislative, judicial, or administrative action, sometimes with retroactive
effect.
Special tax considerations may apply to certain types of investors
subject to special treatment under the Code (including, for example, insurance
companies, banks and tax-exempt organizations).
66
<PAGE>
Qualification as a Regulated Investment Company. Each Portfolio has
-----------------------------------------------
elected to be taxed as a regulated investment company under Subchapter M of 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) and at least 90% of
its tax-exempt income (net of expenses allocable thereto) 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
for the taxable year and will therefore count toward satisfaction of the
Distribution Requirement.
If a Portfolio has a net capital loss (i.e., an excess of capital
losses over capital gains) for any year, the amount thereof may be carried
forward up to eight years and treated as a short-term capital loss which can be
used to offset capital gains in such future years. As of March 31, 2000, the
Money Market, High Yield and EMD Portfolios had capital loss carryforwards of
$34,543; $175,885 and $780,615, respectively, each of which expires in 2007. As
of March 31, 2000, the Money Market, Income, High Yield, EMD, Insiders Select
and Focus List Portfolios had capital loss carryforwards of $1,279; $127,545;
$5,284,854; $2,855,992; $393,572 and $203,196, respectively, each of which
expires in 2008. Under Code Sections 382 and 383, if a Portfolio has an
ownership change, then the Portfolio's use of its capital loss carryforwards in
any year following the ownership change will be limited to an amount equal to
the net asset value of the Portfolio immediately prior to the ownership change
multiplied by the long-term tax-exempt rate (which is published monthly by the
Internal Revenue Service (the "IRS")) in effect for the month in which the
ownership change occurs (the rate for July 2000 is 5.79%). The Portfolios will
use their best efforts to avoid having an ownership change. However, because of
circumstances which may be beyond the control or knowledge of a Portfolio, there
can be no assurance that a Portfolio will not have, or has not already had, an
ownership change. If a Portfolio has or has had an ownership change, then the
Portfolio will be subject to federal income taxes on any capital gain net income
for any year following the ownership change in excess of the annual limitation
on the capital loss carryforwards unless distributed by the Portfolio. Any
distribution of such capital gain net income will be taxable to shareholders as
described under "Portfolio Distributions," below.
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
(including municipal obligations) 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 while 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,
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 a
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<PAGE>
Portfolio elects otherwise), generally will be treated as ordinary income or
loss to the extent attributable to changes in foreign currency exchange rates.
Further, the Code also treats as ordinary income a portion of the
capital gain attributable to a transaction where substantially all of the
expected return 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 such gain that is treated
as ordinary income 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
on the type of instrument at issue, reduced by the sum of: (1) prior inclusions
of ordinary income items from the conversion transaction and (2) the capitalized
interest on acquisition indebtedness under Code Section 263(g). However, if a
Portfolio has a built-in loss with respect to a position that becomes a part of
a conversion transaction, the character of such loss will be preserved upon a
subsequent disposition or termination of the position. No authority exists that
indicates that the character of the income treated as ordinary under this rule
will not pass through to the Portfolios' 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 (as applicable, depending
on the type of the Portfolio involved) 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 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 a 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 Section 1256 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 previously was
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 Section 1256 Contracts) generally is 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.
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<PAGE>
A Portfolio may enter into notional principal contracts, including
interest rate swaps, caps, floors, and collars. Treasury Regulations provide, in
general, that the net income or net deduction from a notional principal contract
for a taxable year is included in or deducted from gross income for that taxable
year. The net income or deduction from a notional principal contract for a
taxable year equals the total of all of the periodic payments (generally,
payments that are payable or receivable at fixed periodic intervals of one year
or less during the entire term of the contract) that are recognized from that
contract for the taxable year and all of the non-periodic payments (including
premiums for caps, floors, and collars) that are recognized from that contract
for the taxable year. No portion of a payment by a party to a notional principal
contract is recognized prior to the first year to which any portion of a payment
by the counterparty relates. A periodic payment is recognized ratably over the
period to which it relates. In general, a non-periodic payment must be
recognized over the term of the notional principal contract in a manner that
reflects the economic substance of the contract. A non-periodic payment that
relates to an interest rate swap, cap, floor, or collar is recognized over the
term of the contract by allocating it in accordance with the values of a series
of cash-settled forward or option contracts that reflect the specified index and
notional principal amount upon which the notional principal contract is based
(or under an alternative method provided in the Treasury regulations).
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 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 the 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 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 be taxable to the
shareholders as an ordinary income dividend.
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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, a
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 assets
must consist of cash and cash items, U.S. government securities, securities of
other regulated investment companies, and securities of other issuers (provided
that, as to each issuer, the Portfolio has not invested more than 5% of the
value of the Portfolio's total assets in securities of each such issuer and the
Portfolio does not hold more than 10% of the outstanding voting securities of
each 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, FNMA, GNMA, 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 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 may be eligible for the
dividends-received deduction ("DRD") 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 taxable income for
the 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)). (Tax-exempt interest on municipal
obligations is not subject to the excise tax.) 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: (1) reduces 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)
excludes 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, includes such gains and losses in determining the company's
ordinary taxable income for the succeeding calendar year).
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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 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. Distributions
attributable to dividends received by a Portfolio from domestic corporations
will qualify for the 70% DRD for corporate shareholders only to the extent
discussed below. Distributions attributable to interest received by a Portfolio
will not, and distributions attributable to dividends paid by a foreign
corporation generally should not, qualify for the DRD.
Ordinary income dividends paid by a Portfolio with respect to a
taxable year may qualify for the 70% DRD 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 dividends received by the
Portfolio from domestic corporations for the taxable year. No DRD will be
allowed with respect to any 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) during the 90-day period (180-day period in
the case of certain preferred stock) beginning on the date that is 45 days (90
days in the case of certain preferred stock) before the date on which such share
becomes ex-dividend with respect to such dividend, excluding for this purpose,
under the rules of Code section 246(c), 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 the stock on
which the dividend is paid is treated as debt-financed under the rules of Code
Section 246A. Moreover, the DRD 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 the Portfolio or (2) by application
of Code Section 246(b) which in general limits the DRD to 70% of the
shareholder's taxable income (determined without regard to the DRD and certain
other items). With respect to the Money Market Portfolio, International Equity
Portfolio and the EMD Portfolio, only an insignificant portion of the Portfolio
will be invested in stock of domestic corporations; therefore the ordinary
dividends distributed by the Portfolio generally will not qualify for the DRD
for corporate shareholders.
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. If net capital gain is distributed and designated
as a capital gain dividend, it 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% of the capital gain recognized upon a
Portfolio's disposition of domestic qualified small business stock will be
subject to tax.
Conversely, if a Portfolio elects to retain its net capital gain, the
Portfolio will be subject to tax 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
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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.
Alternative Minimum Tax ("AMT") is imposed in addition to, but only to
the extent it exceeds, the regular income tax and is computed at a maximum
marginal rate of 28% for non-corporate 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 DRD 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, corporate
shareholders generally will be required to take the full amount of any dividend
received from a Portfolio into account (without a DRD) in determining their
adjusted current earnings.
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 the 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 the Portfolio's assets to be invested in various
countries is not known. If more than 50% of the value of the Portfolio's total
assets at the close of its taxable year consist of the stock or securities of
foreign corporations, the Portfolio may elect to pass through to the Portfolio's
shareholders the amount of foreign taxes paid by the Portfolio. If the Portfolio
so elects, each shareholder would be required to include in gross income, even
though not actually received, his pro rata share of the foreign taxes paid by
the Portfolio, but would be treated as having paid his pro rata share of such
foreign taxes and would therefore be allowed to either deduct such amount in
computing taxable income or use such amount (subject to various Code
limitations) as a foreign tax credit against federal income tax (but not both).
For purposes of the foreign tax credit limitation rules of the Code, each
shareholder would treat as foreign source income his pro rata share of such
foreign taxes plus the portion of dividends received from the Portfolio
representing income derived from foreign sources. No deduction for foreign taxes
could be claimed by an individual shareholder who does not itemize deductions.
Each shareholder should consult his own tax adviser regarding the potential
application of foreign tax credit rules.
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 Portfolio (or of 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, recognized net capital gain, 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 such
distributions 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 a month will be
deemed to have been received by the shareholders (and paid by a Portfolio) on
December 31 of such calendar year if such dividends are actually paid in January
of the following year. Shareholders will be
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advised annually as to the U.S. federal income tax consequences of distributions
made (or deemed made) during the year.
Each 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 report the receipt of interest or
dividend income properly, or (3) who has failed to certify to the Portfolio that
it is not subject to backup withholding or is an exempt recipient (such as a
corporation).
Sale or Redemption of Shares. The Money Market Portfolio seeks to
----------------------------
maintain a stable net asset value of $1.00 per share; however, there can be no
assurance that the Portfolio will be able to maintain such value. If the net
asset value varies from $1.00 per share, and for all the Portfolios other than
the Money Market Portfolio, a shareholder will recognize gain or loss on the
sale or redemption of shares of a Portfolio (including an exchange of shares of
a Portfolio for shares of another 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 same 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 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 DRD 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 Portfolio or another fund at a
reduced sales load pursuant to a right 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 such shares but shall be treated as incurred on the acquisition of the
subsequently acquired shares.
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 a 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 such foreign shareholder will be subject to U.S. withholding
tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount
of the dividend. Furthermore, such a foreign shareholder in the International
Equity Portfolio, S&P STARS Portfolio or Focus List Portfolio may be subject to
U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) on the
gross income resulting from the Portfolio's election to treat any foreign taxes
paid by it as paid by its shareholders, but may not be allowed a deduction
against such gross income or a credit against the U.S. withholding tax for the
foreign shareholder's pro rata share of such foreign taxes which it is treated
as having paid. Such a 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 the Portfolio that are
designated as undistributed capital gains.
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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 the 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 a 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 SAI. 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.
DIVIDENDS -- MONEY MARKET PORTFOLIO
The Money Market Portfolio's net investment income for dividend
purposes consists of (i) interest accrued and original issue discount earned on
the Portfolio's assets, (ii) plus the amortization of market discount and minus
the amortization of market premium on such assets, (iii) less accrued expenses
directly attributable to the Portfolio and the general expenses (e.g. legal,
accounting and trustees' fees) of the Trust prorated to the Portfolio on the
basis of its relative net assets. Any realized short-term capital gains may
also be distributed as dividends to Portfolio investors.
The Trust uses its best efforts to maintain the NAV of the Money
Market Portfolio at $1.00. As a result of a significant expense or realized or
unrealized loss incurred by the Portfolio, the Portfolio's NAV may fall below
$1.00.
PORTFOLIO TRANSACTIONS
Information in this section relating to the portfolio turnover of, and
brokerage commissions paid by, the EMD Portfolio prior to July 29, 1999
represent the portfolio turnover of, and brokerage commissions paid by, the
Portfolio's predecessor, the Emerging Markets Debt Portfolio, a series of BSIT.
Money Market Portfolio. Subject to the general control of the Board,
the Adviser is responsible for, makes decisions with respect to, and places
orders for all purchases and sales of portfolio securities for the Money Market
Portfolio. The Adviser purchases portfolio securities for the Portfolio
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either directly from the issuer or from dealers who specialize in money market
instruments. Such purchases are usually without brokerage commissions. In making
portfolio investments, the Adviser seeks to obtain the best net price and the
most favorable execution of orders. To the extent that the execution and price
offered by more than one dealer are comparable, the Adviser may, in its
discretion, effect transactions in portfolio securities with dealers who provide
the Trust with research advice or other services.
The Adviser may seek to obtain an undertaking from issuers of
commercial paper or dealers selling commercial paper to consider the repurchase
of such securities from the Money Market Portfolio prior to their maturity at
their original costs plus interest (interest may sometimes be adjusted to
reflect the actual maturity of the securities) if the Adviser believes that the
Portfolio's anticipated need for liquidity makes such action desirable. Certain
dealers (but not issuers) have charged and may in the future charge a higher
price for commercial paper where they undertake to repurchase prior to maturity.
The payment of a higher price in order to obtain such an undertaking reduces the
yield which might otherwise be received by the Portfolio on the commercial
paper. The Board has authorized the Adviser to pay a higher price for commercial
paper where it secures such an undertaking if the Adviser believes that
the prepayment privilege is desirable to assure the Portfolio's liquidity and
such an undertaking cannot otherwise be obtained.
Investment decisions for the Money Market Portfolio are made
independently from those for another of the other Portfolios or other investment
company series or accounts managed by the Adviser. Such other accounts may also
invest in the same securities as the Portfolio. When purchases or sales of the
same security are made at substantially the same time on behalf of such other
accounts, transactions are averaged as to price, and available investments
allocated as to amount, in a manner which the Adviser believes to be equitable
to each account, including the Portfolio. In some instances, this investment
procedure may adversely affect the price paid or received by the Portfolio or
the size of the position obtainable for the Portfolio. To the extent permitted
by law, the Adviser may aggregate the securities to be sold or purchased for the
Portfolio with those to be sold or purchased for such other accounts in order to
obtain best execution.
The Money Market Portfolio will not execute portfolio transactions
through, acquire portfolio securities issued by, make savings deposits in, or
enter into repurchase agreements with Bear Sterns or the Adviser or any of their
affiliated persons (as defined in the 1940 Act), except as permitted by the SEC.
In addition, with respect to such transactions, securities, deposits and
agreements, the Portfolio will not give preference to service providers with
which the Portfolio enters into agreements.
The Money Market Portfolio may seek profits through short-term
trading. The Portfolio's annual portfolio turnover will be relatively high, but
brokerage commissions are normally not paid on money market instruments and the
Portfolio turnover is not expected to have a material effect on its net income.
The Portfolio's turnover rate is expected to be zero for regulatory reporting
purposes.
Fixed Income Funds. BSAM assumes general supervision over placing
orders on behalf of each Portfolio for the purchase or sale of investment
securities. Purchases and sales of portfolio securities usually are principal
transactions. Fixed Income Fund 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 Fixed Income Funds
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. Fixed Income Fund portfolio transactions are
allocated to various dealers by its portfolio managers in their best judgment.
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Equity Funds. 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 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'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 determines in good faith that such commission is reasonable
in terms of the transaction or the overall responsibility of BSAM to a 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.
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.
In allocating brokerage commissions, BSAM may also take into
consideration, consistent with applicable rules adopted by the NASD, the
brokers' attitudes toward and interest in the sale of Portfolio shares in
general and the marketing and sales support provided by such brokers to the
Portfolios in particular. In such cases, BSAM may execute Portfolio trades (and
trades for other accounts managed by BSAM) directly through broker-dealers that
sell shares of the Portfolios or through other broker-dealers with which such
selling broker-dealers have clearing arrangements.
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.
Allocation of Initial Public Offerings ("IPOs"). With respect to
investment in large capitalization companies, the Equity Funds do not generally
participate in the market for IPOs because the portfolio management team follows
a disciplined screening process that excludes securities that do not meet
stringent operating history, market capitalization, liquidity, price/earnings
ratio, cash flow, position size and investment horizon criteria. Equity Funds
that invest in small capitalization companies do occasionally participate in the
IPO market, but the portfolio management team generally prefers companies with
earnings histories and acceptable price multiples. The vast majority of IPOs
allocated to BSAM are likely to be acquired by BSAM's private investment funds,
which pay BSAM performance fee as well as asset-based fees for advisory
services. These accounts are designed for aggressive investors seeking above-
market returns who can tolerate virtually unrestricted investment strategies and
the market risks, volatility, illiquidity, turnover and limited availability
associated with IPOs.
Additional Information About Portfolio Transactions. Prior to each
quarterly meeting of the Board of Trustees of the Funds, BSAM will ascertain
from the Bear Stearns block desk whether any transaction (other than agency
cross trades) was executed during the quarter at a commission rate of less
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than 3(cent) a share for a customer other than the Funds and will report to the
Funds' Board of Trustees the reason for such reduced commission rate. BSAM's
head equity trader, in conjunction with the Funds' equity portfolio managers,
continually reviews the performance of all of the broker-dealers who execute
agency and over-the-counter transactions in equity securities for the Funds. The
review criteria applicable to each broker-dealer include an appraisal of the
execution capability of such broker-dealer based on the actual trades executed
and the prices obtained therefor; the willingness of the broker-dealer to commit
its own capital to complete transactions where necessary; the commissions
charged by the broker-dealer relative to the commissions charged by other
broker-dealers for similar transactions; the extent, timeliness and value of
research and market information provided by the broker-dealer to BSAM's head
equity trader and the portfolio managers of the Funds; the financial soundness
of the broker-dealer; and the general responsiveness of the broker-dealer to
BSAM's trading requirements. Each quarter, BSAM's head equity trader will record
the results of the brokerage review in a report to BSAM's Best Execution
Committee. BSAM's Best Execution Committee will pre-approve all soft-dollar
arrangements with broker-dealers, including trial programs, BSAM may also
execute trader through broker-dealer approval by the head trader. Each quarter,
a comprehensive list of brokers used by BSAM will be presented for approval to
the Best Execution Committee.
Portfolio Turnover. The portfolio turnover rate is a measure of the
average buying and selling activity in a Portfolio. It refers to the percentage
of the Portfolio that is bought and sold each year. Portfolio turnover may vary
from year to year as well as within a year. The following table shows the
portfolio turnover rate for each Portfolio for the last three fiscal years ended
March 31.
PORTFOLIO TURNOVER
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2000 1999 1998
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Income 158% 107% 245%
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High Yield 71% 102% 140%*
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EMD 92% 82% 129%
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S&P STARS 55% 76% 173%
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Insiders Select Fund 76% 100% 116%
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Large Cap 56% 38% 62%
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Small Cap 66% 84% 90%
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Focus List 56% 84% 29%**
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Balanced 86% 46% 13%**
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International Equity 96% 115% 3%**
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* From January 2, 1998 (commencement of investment operations) to March 31,
1998.
** From December 29, 1997 (commencement of investment operations) to March 31,
1998.
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.
77
<PAGE>
To the extent consistent with applicable provisions of the 1940 Act
and the rules and exemptions adopted by the SEC thereunder, the Board 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, Bear Stearns may directly execute such
transactions for each Portfolio on the floor of any national securities
exchange, provided (i) the Board has expressly authorized Bear Stearns to effect
such transactions, and (ii) Bear Stearns annually advises the Board 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.
The following table shows the total brokerage commissions that each
Portfolio paid during the last three fiscal years ended March 31 (including the
amount paid to Bear Stearns) For the fiscal year ended March 31, 2000, the table
also shows the percentage of total commissions paid to Bear Stearns and the
percentage of total transactions effected through Bear Stearns. No brokerage
commissions were paid by the Money Market or Income Portfolios for the following
periods.
<TABLE>
<CAPTION>
BROKERAGE COMMISSIONS
- ------------------------------------------------------------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------
% of total
transactions
% paid to through Bear
Total paid Bear Stearns Stearns Total paid Total paid
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
High Yield
Total $ 0 0% 0% $ 3,600 $ 0
----- ------
(Paid to Bear Stearns) ($0) ($900) ($0)
- ---------------------------------------------------------------------------------------------------------------
EMD
Total $ 0 0% 0% $ 2,972 $ 0
----- ($0) ($0) ($0)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
S&P STARS
Total $1,710,365 41.61% 39.41% $ 780,970 $ 521,114
----- ($711,620) ($500,570) ($305,271)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
Insiders Select
Total $ 127,168 20.54% 17.12% $ 161,821 $ 59,364
----- ($26,124) ($15,902) ($12,445)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
Large Cap
Total $ 42,449 2.35% 2.58% $ 23,164 $ 26,799
----- ($996) ($1,602) ($522)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
Small Cap
Total $ 88,939 5.13% 1.25% $ 120,832 $ 302,476
----- ($4,560) ($3,540) ($1,728)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
Focus List
Total $ 58,642 100.00% 100.00% $ 23,472 $ 8,274*
----- ($58,642) ($23,472) ($8,238)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
Balanced
Total $ 20,190 42.48% 39.93% $ 12,605 $ 5,528*
----- ($8,576) ($5,688) ($2,598)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
78
<PAGE>
<TABLE>
<CAPTION>
BROKERAGE COMMISSIONS
- ------------------------------------------------------------------------------------------------------------------
2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------
% of total
transactions
% paid to through Bear
Total paid Bear Stearns Stearns Total paid Total paid
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
International Equity
Total $ 196,972 0% 0% $ 67,305 $ 16,474*
----- ($0) ($259) ($0)
(Paid to Bear Stearns)
- ---------------------------------------------------------------------------------------------------------------
</TABLE>
* From December 29, 1997 (commencement of investment operations) to March 31,
1998.
The following information shows the percentage of commissions for
which a Portfolio received research services during the fiscal year ended March
31, 2000: S&P STARS Portfolio: 99.77%; Insiders Select Fund: 99.79%; Large Cap
Portfolio: 100%; Small Cap Portfolio: 94.34%; Focus List Portfolio: 100%;
Balanced Portfolio: 95.96%; International Equity Portfolio: 99.91%.
PERFORMANCE INFORMATION
The following information supplements and should be read in
conjunction with the section in the Prospectus entitled "Risk/Return Summary --
Performance." Performance information in this section relating to the EMD
Portfolio prior to July 29, 1999 represents the performance information of the
Portfolio's predecessor, the Emerging Markets Debt Portfolio, a series of BSIT.
Money Market Portfolio. The "yield" and "effective yield" of the Money
Market Portfolio are calculated separately for each class of shares and in
accordance with the formulas prescribed by the SEC. The seven-day yield for each
class of shares in the Portfolio is calculated by determining the net change in
the value of a hypothetical preexisting account in the Portfolio having a
balance of one share of the class involved at the beginning of the period,
dividing the net change by the value of the account at the beginning of the
period to obtain the base period return, and multiplying the base period return
by 365/7. The net change in the value of an account in the Portfolio includes
the value of additional shares purchased with dividends from the original share
and dividends declared on the original share and any such additional shares, net
of all fees charged to all shareholder accounts in proportion to the length of
the base period and the Portfolio's average account size, but does not include
gains and losses or realized appreciation and depreciation.
In addition, the effective annualized yield may be computed on a
compounded basis (calculated as described above) with respect to each class of a
Portfolio's shares by adding 1 to the base period return, raising the sum to a
power equal to 365/7, and subtracting 1 from the result, according to the
following formula:
EFFECTIVE YIELD = [(BASE PERIOD RETURN + 1)/365/7/] - 1
Similarly, based on calculations described above, 30-day (or one-
month) yields and effective yields may also be calculated.
From time to time, in advertisements or in reports to investors, the
Money Market Portfolio's yield may be quoted and compared to that of other money
market funds or accounts with similar investment objectives and to stock or
other relevant indices. For example, the yield of the
79
<PAGE>
Portfolio may be compared to the iMoneyNet Money Fund Average, which is an
average compiled by iMoney Net Money Fund Report(R), One Research Drive,
Westborough, Massachusetts 01581, a widely-recognized independent publication
that monitors the performance of money market funds, or to the average yields
reported by the Bank Rate Monitor from money market deposit accounts offered by
the 50 leading banks and thrift institutions in the top five standard
metropolitan statistical areas.
The Money Market Portfolio's yield will fluctuate, and any quotation
of yield should not be considered as indicative of its future performance. Since
yields fluctuate, yield data cannot necessarily be used to compare an investment
in Portfolio shares with bank deposits, savings accounts and similar investment
alternatives which often provide an agreed or guaranteed fixed yield for a
stated period of time. Investors should remember that performance and yield are
generally functions of the kind and quality of the investments held in a
portfolio, portfolio maturity, operating expenses net of waivers and expense
reimbursements, and market conditions. Any fees charged by banks with respect to
customer accounts investing in shares of the Portfolio will not be included in
yield calculations; such fees, if charged, would reduce the actual yield from
that quoted.
Current Yield. The current yield for each class reflects the waiver
and reimbursement of certain fees and expenses by the investment adviser. The
current yield of a Fixed Income Fund is computed by dividing the net investment
income per share earned during the period by the maximum offering price per
share on the last day of the period, according to the following formula:
YIELD =2[(a - b + 1)/6/ - 1]
-----
cd
Where:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the period
that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
The following table shows the current yield for the 30-day period
ended March 31, 2000 for each class of shares of the Fixed Income Funds, with
and without the fee waivers and expense reimbursements described in this SAI
under "Management Arrangements -- Investment Advisory Agreement."
CURRENT YIELD FOR THE 30-DAY PERIOD ENDED MARCH 31, 2000
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------
Income High Yield EMD
- ----------------------------------------------------------------------------------------------------------------
With Without With Without With Without
waivers waivers waivers waivers waivers waivers
- ----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Class A 6.24% 2.04% 11.62% 10.98% 6.29% 5.47%
- ----------------------------------------------------------------------------------------------------------------
Class B 5.90% 1.48% 11.51% 10.84% 5.31% 4.60%
- ----------------------------------------------------------------------------------------------------------------
Class C 5.90% 1.48% 11.51% 10.84% 5.25% 4.68%
- ----------------------------------------------------------------------------------------------------------------
Class Y 6.90% 2.48% - - - -
- ----------------------------------------------------------------------------------------------------------------
</TABLE>
80
<PAGE>
Average annual total return of each Portfolio for the 1-, 5-, and 10-
year periods (or for periods of the Portfolio's operations) would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
P(1+T)/n/ = ERV
Where
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a hypothetical $1,000 payment made
at the beginning of the 1-, 5-, or 10-year periods at the end of
the 1-, 5-, or 10-year periods (or fractional portion).
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 NAV (maximum offering price in the case of Class A) per share
at the beginning of a stated period from the NAV 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 NAV (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 NAV 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.
CODE OF ETHICS
Each of BSAM, the Sub-Adviser (collectively the "Advisers") and the
Trust, on behalf of each Portfolio, has adopted a Code of Ethics, that
establishes standards by which certain access persons of the Trust must abide
relating to personal securities trading conduct. Under each Adviser's Code of
Ethics, access persons which include, among others, trustees and officers of the
Trust and employees of the Advisers, 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 Trust or the applicable
Adviser, as the case may be, 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 Trust or the applicable Adviser, as the
case may be. Certain transactions are exempt from item (1) of the previous
sentence, including: (1) in the case of BSAM's Code of Ethics, 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.
81
<PAGE>
Each 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 of BSAM and the Sub-Adviser are required by the Code of Ethics to file
quarterly reports of personal securities investment transactions. Access persons
of the Sub-Adviser are required to preclear securities transactions for all non-
exempt securities and transactions. An access person is not required to report a
transaction over which he or she had no control. Furthermore, a trustee of the
Trust who is not an "interested person" (as defined in the 1940 Act) of the
Trust 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 Trust, 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. Each 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.
INFORMATION ABOUT THE TRUST
S&P STARS Portfolio. BSAM has the right to use the S&P, Standard &
Poor's and STARS trademarks for a fee in connection with the management of
mutual funds and access to STARS through S&P's publicly available subscription
service. Bear Stearns and S&P entered into a License Agreement dated October 1,
1994 that, among other things, (i) grants Bear Stearns the non-exclusive right
to use certain of S&P's proprietary trade names and trademarks for investment
companies based, in whole or in part, on the STARS System, (ii) gives S&P the
right to terminate the Agreement if Bear Stearns breaches its material terms,
S&P ceases to publish STARS, legislative or regulatory changes negatively affect
S&P's ability to license its trade names or trademarks, or certain litigation,
(iii) provides that Bear Stearns will pay to S&P annual license fees based on a
percentage of the net assets of any investment companies subject to the
Agreement and (iv) provides for a partial reduction of the license fees to
offset certain marketing expenses incurred by Bear Stearns in connection with
the Portfolio.
STARS is the centerpiece of OUTLOOK, S&P's flagship investment
newsletter that has a high net worth readership of 25,000 weekly subscribers.
STARS reaches more than 74,000 brokers and investment professionals on their
desktop computers through MarketScope, S&P's on-line, real-time equity
evaluation service, which is accessed more than one million times daily. S&P has
more than 130 years' experience in providing financial information and analysis,
offers more than 60 products and employs more than 50 experienced equity
analysts. These analysts consider fundamental factors that are expected to
impact growth, including industry and macroeconomic conditions and a company's
operations, balance sheet, ability to finance growth, competitive market
advantages, earnings per share growth and strength of management.
"Standard & Poor's(R)," "S&P(R)," and "STARS(R)" are trademarks of
Standard & Poor's and have been licensed for use by Bear Stearns. The S&P STARS
Portfolio is not sponsored, managed, advised, sold or promoted by S&P.
Focus List Portfolio. The Adviser may be prohibited from buying an
attractive stock in the Focus List for legal reasons and thus miss an investment
opportunity. Current members of the Focus List Committee are Kathryn Booth and
Elizabeth Mackay, CFA. Ms. Booth is the Director of Global Equity Research and
a Senior Managing Director of Bear Stearns. She is a member of the Investment
Committee and co-chairperson of the Stock Selection Committee. Ms. Booth also
manages the Bear
82
<PAGE>
Stearns research department's Model Portfolio. Ms. Mackay is a Managing Director
and the Chief Investment Strategist for Bear Stearns. Her focus is domestic
financial markets. Ms. Mackay determines Bear Stearns' overall asset allocation
and advises on market trends and specific investment themes.
General. The Trust was organized as a business trust under the laws
of The Commonwealth of Massachusetts pursuant to an Agreement and Declaration of
Trust (the "Trust Agreement") dated September 29, 1994, and commenced operations
on or about April 3, 1995. The Trust is authorized to issue an unlimited number
of shares of beneficial interest, par value $0.001 per share. Each Portfolio's
shares are classified into four classes-Class A, B, C and Y. 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. Shareholders will vote in the
aggregate and not by class, except as otherwise required by law. Portfolio
shares have no preemptive, subscription or conversion rights and are freely
transferable.
Under Massachusetts law, shareholders could, under certain
circumstances, be held personally liable for the obligations of the Portfolio of
which they are shareholders. However, the Trust Agreement disclaims shareholder
liability for acts or obligations of the relevant Portfolio and requires that
notice of such disclaimer be given in each agreement, obligation or instrument
entered into or executed by the Trust or a Trustee. The Trust Agreement provides
for indemnification from the respective Portfolio's property for all losses and
expenses of any shareholder held personally liable for the obligations of a
Portfolio. Thus, the risk of a shareholder incurring financial loss on account
of a shareholder liability is limited to circumstances in which the Portfolio
itself would be unable to meet its obligations, a possibility which the Adviser
believes is remote. Upon payment of any liability incurred by a Portfolio, the
shareholder paying such liability will be entitled to reimbursement from the
general assets of such Portfolio. The Trustees intend to conduct the operations
of each Portfolio in a way so as to avoid, as far as possible, ultimate
liability of the shareholders for liabilities of the Portfolio.
As discussed under "Management of the Trust," each Portfolio
ordinarily will not hold shareholder meetings; however, shareholders under
certain circumstances may have the right to call a meeting of shareholders for
the purpose of voting to remove Trustees. To date, the Board has authorized the
creation of eleven Portfolios. All consideration received by the Trust for
shares of a Portfolio and all assets in which such consideration is invested
will belong to that Portfolio (subject only to the rights of creditors of the
Trust) and will be subject to the liabilities related thereto. The assets
attributable to, and the expenses of, a Portfolio (and as to classes within the
Portfolio) are treated separately from those of the other Portfolios (and
classes). The Trust has the ability to create, from time to time, new Portfolios
without shareholder approval.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted under the provisions of the 1940 Act or applicable state law or
otherwise to the holders of the outstanding voting securities of an investment
company, such as the Trust, will not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each portfolio affected by such matter. Rule 18f-2 further provides that a
Portfolio shall be deemed to be affected by a matter unless it is clear that the
interests of such portfolio in the matter are identical or that the matter does
not affect any interest of such portfolio. However, Rule 18f-2 exempts the
selection of independent accountants and the election of Trustees from the
separate voting requirements of Rule 18f-2.
The term "majority of the outstanding shares" of a Portfolio means the
vote of the lesser of (i) 67% or more of the shares of the Portfolio present at
a meeting, if the holders of more than 50% of the outstanding shares of the
Portfolio are present or represented by proxy, or (ii) more than 50% of the
outstanding shares of the Portfolio.
The Trust will send annual and semi-annual financial statements to all
its shareholders.
83
<PAGE>
As of June 30, 2000, the following shareholders owned, directly or
indirectly, 5% or more of the indicated class of Portfolio shares. Unless
otherwise noted, the Trust believes that the following information reflects
record ownership only.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- ------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Money Market -- Bear Stearns Securities Corp 5.67%
Class Y FBO 102-05752-11, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.86%
FBO 04941252-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 16.98%
FBO 04941299-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Income -- Class A Bear Stearns Securities Corp 9.99%
FBO 051-29339-12, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 8.47%
FBO 222-12842-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Income -- Class B Bear Stearns Securities Corp 7.75%
FBO 420-28188-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 9.86%
FBO 130-45003-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.31%
FBO 348-20543-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Dean Witter Reynolds Customer for 10.18%
James A. Moran, P.O.Box 290, Church Street Station (beneficial
New York NY 10008-0250 owner)
- ------------------------------------------------------------------------------------------------
Income -- Class C Bear Stearns Securities Corp 8.46%
FBO 498-00055-18, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
</TABLE>
84
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- ------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Bear Stearns Securities Corp 5.34%
FBO 498-00056-17, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.85%
FBO 220-57282-11, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Income -- Class Y Bear Stearns Securities Corp 11.42%
FBO 049-40503-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 11.37%
FBO 051-98474-12, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 9.83%
FBO 046-03216-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 7.02%
FBO 049-40716-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 17.75%
FBO 051-37549-11, 1 Metrotech Center North
Brooklyn NY 11201-3859
- ------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.67%
FBO 051-32810-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
High Yield -- Class A Mark Pinto 12.43%
Trust Fox & Co, DTD 12/16/67 beneficial
P.O. Box 976, New York NY 10268 owner)
- -----------------------------------------------------------------------------------------------------------
High Yield -- Class C Bear Stearns Securities Corp 5.64%
FBO 028-62790-21, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
EMD -- Class A Balsa & Co, C/O Chase Manhattan Bank 13.86%
Grand Central Station, P.O. Box 1768 beneficial
New York NY 10163-1768 owner)
- -----------------------------------------------------------------------------------------------------------
</TABLE>
85
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- ------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Charles Schwab & Co Inc 11.18%
FBO Spec A/C for Benefit of Customers
Attn: Mutual Funds, 101 Montgomery Street
San Francisco CA 94104
- -----------------------------------------------------------------------------------------------------------
EMD -- Class B Fiserv Securities Inc, FAO 60505356 6.44%
Attn: Mutual Funds, One Commerce Square,
2005 Market Street Suite 1200, Philadelphia PA 19103
- -----------------------------------------------------------------------------------------------------------
EMD -- Class C Bear Stearns Securities Corp 14.10%
FBO 211-18748-10, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 7.23%
FBO 031-19213-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
S & P STARS -- Class Y Custodial Trust Company 77.35%
Attn: Jonathan Brown ACCT/CTRL
101 Carnegie Center, Princeton NJ 08540
- -----------------------------------------------------------------------------------------------------------
Insiders Select -- Class Y Bear Stearns Securities Corp 9.44%
FBO 722-90359-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.84%
FBO 748-51683-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 11.80%
FBO 025-06755-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 12.44%
FBO 048-33878-17, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Large Cap -- Class A Bear Stearns Securities Corp 9.62%
FBO 200-40445-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 9.62%
FBO 200-40444-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
</TABLE>
86
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- ------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- ------------------------------------------------------------------------------------------------
<S> <C> <C>
Large Cap -- Class B Bear Stearns Securities Corp 5.87%
FBO 051-35974-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 6.87%
FBO 033-89223-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Large Cap -- Class Y Bear Stearns Securities Corp 7.54%
FBO 049-40503-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 6.95%
FBO 051-37142-12, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Strafe Co, FBO Levin TR FBO Danielle Young 9.39%
A C 6863471800, P.O. Box 160, (beneficial
Westerville OH 43086-0160 owner)
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 7.74%
FBO 051-32810-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 22.54%
FBO 049-41307-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Small Cap -- Class A Bear Stearns Securities Corp 5.82%
FBO 049-40985-10, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Small Cap -- Class Y Bear Stearns Securities Corp 7.16%
FBO 049-40880-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Custodial Trust Company 20.93%
Attn: Jonathan Brown ACCT/CTRL
101 Carnegie Center, Princeton NJ 08540
- -----------------------------------------------------------------------------------------------------------
Robert Morris College 9.01%
Endowment Account 724035728, Attn: Ronald Arnold CFO (beneficial
401 South State Street, Chicago IL 60605 owner)
- -----------------------------------------------------------------------------------------------------------
</TABLE>
87
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- -----------------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Focus List -- Class A The Bear Stearns Co Inc, 21.39%
Cash or Deferred Compensation Plan
Custodial Trust Co., 115 S Jefferson Road
Whippany NJ 07981
- -----------------------------------------------------------------------------------------------------------
Focus List -- Class B Bear Stearns Securities Corp 9.61%
FBO 001-00279-10, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Ed Blakey Investments LLC 7.24%
1314 Bay Ridge Drive (beneficial
Benton LA 71006-3482 owner)
- -----------------------------------------------------------------------------------------------------------
Focus List -- Class C Bear Stearns Securities Corp 13.91%
FBO 001-00279-10, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Balanced -- Class A Bear Stearns Securities Corp 18.56%
FBO 001-00315-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 9.28%
FBO 051-26132-17, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Balanced -- Class B Bear Stearns Securities Corp 32.53%
FBO 001-00315-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Stifel Nicolaus Co Inc 11.58%
A C 3124-3738, Jane Faulkner (beneficial
501 North Broadway, St Louis MO 63102 owner)
- -----------------------------------------------------------------------------------------------------------
Balanced -- Class C Bear Stearns Securities Corp 48.12%
FBO 001-00315-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
First Clearing Corporation 12.08%
A C 4113-3712, Joe A. Dewberry (beneficial
4265 County Road 268, Five Points AL 36855-2801 owner)
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.50%
FBO 984-62194-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
</TABLE>
88
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- -----------------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
- -----------------------------------------------------------------------------------------------------------
Balanced -- Class Y Bear Stearns Securities Corp 9.32%
FBO 051-37445-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 17.30%
FBO 049-40526-16, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 5.83%
FBO 049-40474-18, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 8.56%
FBO 038-13162-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 26.27%
FBO 049-40122-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 7.56%
FBO 040-58124-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 6.96%
FBO 051-38428-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
International Equity Bear Stearns Securities Corp 6.10%
-- Class A FBO 037-13145-19, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
The Bear Stearns Co Inc 23.25%
Cash or Deferred Compensation Plan
Custodial Trust Co., 115 S Jefferson Road
Whippany NJ 07981
- -----------------------------------------------------------------------------------------------------------
International Equity Bear Stearns Securities Corp 5.45%
-- Class B FBO 001-00317-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
International Equity Bear Stearns Securities Corp 10.27%
-- Class C FBO 001-00317-14, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
</TABLE>
89
<PAGE>
<TABLE>
<CAPTION>
- -----------------------------------------------------------------------------------------------------------
FIVE PERCENT SHAREHOLDERS OF THE PORTFOLIOS
- -----------------------------------------------------------------------------------------------------------
Portfolio and class Name and address Percentage owned
- -----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Bear Stearns Securities Corp 5.44%
FBO 028-62790-21, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 14.91%
FBO 031-19222-15, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
Bear Stearns Securities Corp 16.91%
FBO 062-30317-13, 1 Metrotech Center North
Brooklyn NY 11201-3859
- -----------------------------------------------------------------------------------------------------------
</TABLE>
CUSTODIANS, TRANSFER AND DIVIDEND DISBURSING AGENT,
COUNSEL AND INDEPENDENT AUDITORS
Custodians -- General. CTC, 101 Carnegie Center, Princeton, New Jersey
---------------------
08540, an affiliate of Bear Stearns, is the custodian for each Portfolio other
than the EMD Portfolio. Under a custody agreement, CTC holds each Portfolio's
securities and keeps all necessary accounts and records. For its services, each
Portfolio pays CTC an annual fee of the greater of 0.01% of $0 to $1 billion,
0.08% of $1 billion to $2 billion, 0.07% of $2 billion to $5 billion and 0.05%
of the domestic assets over $5 billion 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 transactions charges that are payable monthly.
Brown Brothers Harriman & Co. ("Brown Brothers"), 40 Water Street,
Boston, Massachusetts 02109, is the custodian of the EMD Portfolio's securities
and cash and also maintains the Portfolio's accounting records. Brown Brothers
has appointed sub-custodians from time to time to hold certain securities
purchased by the Portfolio in foreign countries and to hold cash and currencies
for the Portfolio.
Foreign Custody. Rule 17f-5 under the 1940 Act, which governs the
---------------
custody of investment company assets outside the United States, allows a mutual
fund's board of directors to delegate to "Foreign Custody Managers" the
selection and monitoring of foreign sub-custodian arrangements for the Trust's
assets. Accordingly, the Board delegated these responsibilities to CTC and
Brown Brothers pursuant to foreign custody manager agreements dated November 12,
1998 and November 25, 1998, respectively. As Foreign Custody Managers, CTC and
Brown Brothers must (a) determine that Trust assets held by a foreign sub-
custodian will be subject to reasonable care, based on the standards applicable
to custodians in the relevant market; (b) determine that the Trust's foreign
custody arrangements are governed by written contracts in compliance with Rule
17f-5 (or, in the case of a compulsory depository, by such a contract and/or
established practices or procedures); and (c) monitor the appropriateness of
these arrangements and any material change in the relevant contract, practices
or procedures. In determining appropriateness, CTC and Brown Brothers will not
evaluate a particular country's investment risks, such as (a) the use of
compulsory depositories, (b) such country's financial infrastructure, (c) such
country's prevailing custody and settlement practices, (d) nationalization,
expropriation or other governmental actions, (e) regulation of the banking or
securities industry, (f) currency controls, restrictions, devaluations or
fluctuations, and (g) market conditions that affect the
90
<PAGE>
orderly execution of securities transactions or affect the value of securities.
CTC and Brown Brothers will provide to the Trust quarterly written reports
regarding the Trust's foreign custody arrangements.
Transfer and Dividend Disbursing Agent. PFPC, Bellevue Corporate
--------------------------------------
Center, 400 Bellevue Parkway, Wilmington, Delaware 19809, is each Portfolio's
transfer agent, dividend disbursing agent and registrar.
Neither CTC, Brown Brothers nor PFPC participates in determining the
investment policies of any Portfolio or which securities are to be purchased or
sold by any Portfolio.
Counsel. Kramer Levin Naftalis & Frankel LLP, 919 Third Avenue, New
-------
York, New York 10022, is counsel for the Trust.
Independent Auditors. Deloitte & Touche LLP, Two World Financial
--------------------
Center, New York, New York 10281-1434, independent auditors, are the independent
auditors of the Trust.
FINANCIAL STATEMENTS
The Trust's annual report to shareholders for the fiscal year ended
March 31, 2000 are separate documents supplied with this SAI, and the financial
statements, accompanying notes and report of independent auditors appearing
therein are incorporated by reference into this SAI.
91
<PAGE>
APPENDIX
The following describes ratings assigned to money market funds by S&P
and Moody's and to debt securities by S&P, Moody's, Fitch and Thomson BankWatch.
S&P Money Market Fund Ratings
Money market fund ratings assess the safety of invested principal.
AAAm. Safety is excellent. Superior capacity to maintain principal
----
value and limit exposure to loss.
AAm. Safety is very good. Strong capacity to maintain principal value
---
and limit exposure to loss.
Am. Safety is good. Sound capacity to maintain principal value and
--
limit exposure to loss.
BBBm. Safety is fair. Adequate capacity to maintain principal value
----
and limit exposure to loss.
BBm. Safety is uncertain. Vulnerable to loss of principal value.
---
Bm. Safety is limited. Very vulnerable to loss of principal value.
--
CCCm. Extremely vulnerable to loss of principal value.
----
Dm. Fund has failed to maintain principal value; realized or
--
unrealized losses exceed 0.5% of net asset value.
G. The letter "G" follows the rating symbol when a fund's portfolio
-
consists primarily of direct U.S. government securities.
Plus (+) or minus (-). The ratings may be modified by the addition of
---------------------
a plus or minus sign to show relative standing within the rating categories.
A money market fund rating is not directly comparable with an S&P
issue-specific rating due to differences in investment characteristics, rating
criteria, and creditworthiness of portfolio investments. For example, a money
market fund portfolio provides greater liquidity, price stability, and
diversification than a long-term bond, but not necessarily the credit quality
that would be indicated by the corresponding issue rating. Ratings are not
commentaries on yield levels.
A money market fund rating is not a recommendation to buy, sell, or
hold any security held or issued by the fund, inasmuch as it does not comment as
to yield or suitability for a particular investor. Further, the rating may be
changed, suspended, or withdrawn as a result of changes in or unavailability of
information relating to the fund. The ratings are based on current information
furnished to Standard & Poor's by the issuer or obtained by S&P from other
sources it considers reliable. S&P does not perform an audit in connection with
any rating and may, on occasion, rely on unaudited financial information. The
ratings may be changed, suspended, or withdrawn as a result of changes in, or
unavailability of, such information, or based on other circumstances.
A-1
<PAGE>
Moody's Money Market Fund Ratings
Credit Quality Rating Definitions
---------------------------------
Moody's Money Market Fund Ratings are opinions of the investment quality of
shares in mutual funds and similar investment vehicles which principally invest
in short-term fixed income obligations. As such, these ratings incorporate
Moody's assessment of a fund's published investment objectives and policies, the
creditworthiness of the assets held by the fund, as well as the management
characteristics of the fund. The ratings are not intended to consider the
prospective performance of a fund with respect to appreciation, volatility of
net asset value, or yield.
The rating definitions are as follows:
Aaa. Money market funds rated Aaa are judged to be of an investment quality
---
similar to Aaa-rated fixed income obligations, that is, they are judged to be of
the best quality.
Aa. Money market funds rated Aa are judged to be of an investment quality
--
similar to Aa-rated fixed income obligations, that is, they are judged to be of
high quality by all standards.
A. Money market funds rated A are judged to be of an investment quality
-
similar to A-rated fixed income obligations, that is, they are judged to possess
many favorable investment attributes and are considered as upper-medium-grade
investment vehicles.
Baa. Money market funds rated Baa are judged to be of an investment quality
---
similar to Baa-rated fixed income obligations, that is, they are considered as
medium-grade investment vehicles.
Ba. Money market funds rated Ba are judged to be of an investment quality
--
similar to Ba-rated fixed income obligations, that is, they are judged to have
speculative elements.
B. Money market funds rated B are judged to be of an investment quality
-
similar to B-rated fixed income obligations, that is, they generally lack
characteristics of desirable investment.
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.
BB, B, CCC, CC and C. Debt rated in these categories is regarded, on
--------------------
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation, and C the highest degree of
speculation. While such debt likely will have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
A-2
<PAGE>
CI. The rating CI is reserved for income bonds on which no interest
--
is being paid.
D. Debt rated D is in payment default. The D rating category is used
-
when interest payments or principal payments are not made on the date due even
if the applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The D rating will also be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
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.
S&P Commercial Paper Ratings
A-1. The designation A-1 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.
A-2. 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 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 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 rated A possess many favorable investment attributes and are
-
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered as medium grade obligations,
---
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba. Bonds that are rated Ba are judged to have speculative elements.
--
Their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B. Bonds that are rated B generally lack characteristics of the
-
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
A-3
<PAGE>
Caa. Bonds which are rated Caa are of poor standing. Such issues may
---
be in default or there may be present elements of danger with respect to
principal or interest.
Ca. Bonds which are rated Ca represent obligations which are
--
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C. Bonds which are rated C are the lowest rated class of bonds and
-
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
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
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.
Moody's Commercial Paper Ratings
P-1. 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.
P-2. 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.
Fitch Credit Ratings
Long-Term Debt -- Investment Grade
----------------------------------
AAA. Highest credit quality. "AAA" ratings denote the lowest
expectation of credit risk. They are assigned only in case of exceptionally
strong capacity for timely payment of financial commitments. This capacity is
highly unlikely to be adversely affected by foreseeable events.
AA. Very high credit quality. "AA" ratings denote a very low
expectation of credit risk. They indicate very strong capacity for timely
payment of financial commitments. This capacity is not significantly vulnerable
to foreseeable events.
A. High credit quality. "A" ratings denote a low expectation of
credit risk. The capacity for timely payment of financial commitments is
considered strong. This capacity may, nevertheless, be more vulnerable to
changes in circumstances or in economic conditions than is the case for higher
ratings.
BBB. Good credit quality. "BBB" ratings indicate that there is
currently a low expectation of credit risk. The capacity for timely payment of
financial commitments is considered adequate, but adverse changes in
circumstances and in economic conditions are more likely to impair this
capacity. This is the lowest investment-grade category.
A-4
<PAGE>
Long-Term Debt -- Speculative Grade
-----------------------------------
BB. Speculative. "BB" ratings indicate that there is a possibility
of credit risk developing, particularly as the result of adverse economic change
over time; however, business or financial alternatives may be available to allow
financial commitments to be met. Securities rated in this category are not
investment grade.
B. Highly speculative. "B" ratings indicate that significant credit
risk is present, but a limited margin of safety remains. Financial commitments
are currently being met; however, capacity for continued payment is contingent
upon a sustained, favorable business and economic environment.
CCC, CC, C. High default risk. Default is a real possibility.
Capacity for meeting financial commitments is solely reliant upon sustained,
favorable business or economic developments. A "CC" rating indicates that
default of some kind appears probable. "C" ratings signal imminent default.
DDD, DD, D. Default. The ratings of obligations in this category are
based on their prospects for achieving partial or full recovery in a
reorganization or liquidation of the obligor. While expected recovery values
are highly speculative and cannot be estimated with any precision, the following
serve as general guidelines. "DDD" obligations have the highest potential for
recovery, around 90%-100% of outstanding amounts and accrued interest. "DD"
indicates potential recoveries in the range of 50%-90%, and "D" the lowest
recovery potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated "DDD" have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated "DD" and "D" are generally undergoing a formal
reorganization or liquidation process; those rated "DD" are likely to satisfy a
higher portion of their outstanding obligations, while entities rated "D" have a
poor prospect for repaying all obligations.
Short-Term Debt
F1. Highest credit quality. Indicates the best capacity for timely
payment of financial commitments; may have an added "+" to denote any
exceptionally strong credit feature.
F2. Good credit quality. A satisfactory capacity for timely payment
of financial commitments, but the margin of safety is not as great as in the
case of the higher ratings.
F3. Fair credit quality. The capacity for timely payment of
financial commitments is adequate; however, near-term adverse changes could
result in a reduction to non-investment grade.
B. Speculative. Minimal capacity for timely payment of financial
commitments, plus vulnerability to near-term adverse changes in financial and
economic conditions.
C. High default risk. Default is a real possibility. Capacity for
meeting financial commitments is solely reliant upon a sustained, favorable
business and economic environment.
D. Default. Denotes actual or imminent payment default.
Notes:
"+" or "--" may be appended to a rating to denote relative status
within major rating categories. Such suffixes are not added to the "AAA" long-
term rating category, to categories below "CCC" or to short-term ratings other
than "F1."
"NR" indicates that Fitch does not rate the issuer or issue in
question.
A-5
<PAGE>
"Withdrawn": A rating is withdrawn when Fitch deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
Rating Watch: Ratings are placed on Rating Watch to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive," indicating a
potential upgrade, "Negative," for a potential downgrade, or "Evolving," if
ratings may be raised, lowered or maintained. Rating Watch is typically
resolved over a relatively short period.
Thomson BankWatch Bond Ratings
Thomson BankWatch assesses the likelihood of an untimely repayment of
principal or interest over the term to maturity of long-term debt and preferred
stock which are issued by U.S. commercial banks, thrifts and non-bank banks;
non-U.S. banks; and broker-dealers. The following summarizes the two highest
rating categories used by Thomson BankWatch for long-term debt ratings:
AAA. This designation represents the highest category assigned by
---
Thomson BankWatch to long-term debt and indicates that the ability to repay
principal and interest on a timely basis is very high.
AA. This designation indicates a superior ability to repay principal
--
and interest on a timely basis with limited incremental risk versus issues rated
in the highest category.
A. The designation indicates the ability to repay principal and
-
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher ratings.
BBB. The lowest investment-grade category; indicates an acceptable
---
capacity to repay principal and interest. "BBB" issues are more vulnerable to
adverse developments (both internal and external) than obligations with higher
ratings.
BB. While not investment grade, the "BB" rating suggests that the
--
likelihood of default is considerably less than for lower-rated issues.
However, there are significant uncertainties that could affect the ability to
adequately service debt obligations.
B. Issues rated "B" show a higher degree of uncertainty and therefore
-
greater likelihood of default than higher-rated issues. Adverse developments
could negatively affect the payment of interest and principal on a timely basis.
CCC. Issues rated "CCC" clearly have a high likelihood of default,
---
with little capacity to address further adverse changes in financial
circumstances.
CC. "CC" is applied to issues that are subordinate to other
--
obligations rated "CCC" and are afforded less protection in the event of
bankruptcy or reorganization.
D. In default.
-
PLUS (+) or MINUS (-). The ratings may include a plus or minus sign
---------------------
designation which indicates where within the respective category the issue is
placed.
Thomson BankWatch Short-Term Ratings
Thomson BankWatch short-term ratings assess the likelihood of an
untimely payment of principal or interest of debt having a maturity of one year
or less. The following summarizes the two highest ratings used by Thomson
BankWatch:
A-6
<PAGE>
TBW-1. This designation represents Thomson BankWatch's highest rating
-----
category and indicates a very high degree of likelihood that principal and
interest will be paid on a timely basis.
TBW-2. This designation indicates that while the degree of safety
-----
regarding timely payment of principal and interest is strong, the relative
degree of safety is not as high as for issues rated TBW-1.
A-7
