AGA SERIES TRUST
STATEMENT OF ADDITIONAL INFORMATION
MAY 1, 1998
This Statement of Additional Information (the "SAI") contains information which
may be of interest to investors but which is not included in the Prospectus of
AGA Series Trust, formerly WNL Series Trust, (the "Trust"). The SAI is not a
prospectus and is only authorized for distribution when accompanied or preceded
by the Prospectus of the Trust dated May 1, 1998. The SAI should be read
together with the Prospectus. Investors may obtain a free copy of the Prospectus
by calling American General Annuity Insurance Company, formerly Western National
Life Insurance Company, (the "Life Company") at 1-800-910-4455.
TABLE OF CONTENTS
PAGE
DEFINITIONS 4
INVESTMENT OBJECTIVES AND POLICIES OF THE TRUST 4
Options 4
Futures Contracts 7
Special Risks of Transactions in Futures Contracts and Related Options 12
Forward Commitments 14
Repurchase Agreements 14
Reverse Repurchase Agreements 15
When-Issued Securities 15
Loans of Portfolio Securities 16
Foreign Securities 16
Foreign Currency Transactions 17
Commercial Mortgage-Backed Securities 22
Zero-Coupon Securities 24
Variable- or Floating-Rate Securities 25
Lower-Grade Securities 26
INVESTMENT RESTRICTIONS 28
Fundamental Investment Restrictions 28
Non-Fundamental Investment Restrictions 29
MANAGEMENT OF THE TRUST 31
Substantial Shareholders 34
Investment Adviser 34
Trust Administration 36
Sub-Advisers 36
Code of Ethics 37
Investment Decisions 37
Brokerage and Research Services 37
DETERMINATION OF NET ASSET VALUE 39
TAXES 41
DIVIDENDS AND DISTRIBUTIONS 43
PERFORMANCE INFORMATION 44
SHAREHOLDER COMMUNICATIONS 46
ORGANIZATION AND CAPITALIZATION 46
PORTFOLIO TURNOVER 46
CUSTODIAN 47
LEGAL COUNSEL 47
INDEPENDENT AUDITORS 47
SHAREHOLDER LIABILITY 47
DESCRIPTION OF NRSRO RATINGS 47
Description of Moody's Corporate Ratings 47
Description of S&P's Corporate Ratings 49
Description of Duff Corporate Ratings 49
Description of Fitch Corporate Ratings 50
Description of Thomson Bankwatch, Inc. Corporate Ratings 51
Description of IBCA Limited and IBCA Inc. Corporate Ratings 51
Description of S&P's Commercial Paper Ratings 52
Description of Moody's Commercial Paper Ratings 52
Description of Duff Commercial Paper Ratings 52
Description of Fitch Commercial Paper Ratings 53
Description of IBCA Limited and IBCA Inc. Commercial Paper Ratings 53
Description of Thomson Bankwatch, Inc. Commercial Paper Ratings 53
FINANCIAL STATEMENTS 53
AGA SERIES TRUST
STATEMENT OF ADDITIONAL INFORMATION
DEFINITIONS
THE "TRUST" - AGA Series Trust, formerly WNL Series Trust "ADVISER" - AGA
Investment Advisory Services, Inc., formerly WNL Investment Advisory Services,
Inc., the Trust's investment adviser.
INVESTMENT OBJECTIVES AND POLICIES OF THE TRUST
The Trust currently offers shares of beneficial interest of seven series (the
"Portfolios") with separate investment objectives and policies. The investment
objectives and policies of each of the Portfolios of the Trust are described in
the Prospectus. The SAI contains additional information concerning certain
investment practices and investment restrictions of the Trust.
Except as described below under "Investment Restrictions," the investment
objectives and policies described in the Prospectus and in the SAI are not
fundamental, and the Trustees may change the investment objectives and policies
of a Portfolio without an affirmative vote of shareholders of the Portfolio.
Except as otherwise noted below, the following descriptions of certain
investment policies and techniques are applicable to all of the Portfolios.
OPTIONS
Each Portfolio, other than the State Street Global Advisors Money Market
Portfolio, may purchase put and call options on portfolio securities in which
they may invest that are traded on a U.S. or foreign securities exchange or in
the over-the-counter market.
COVERED CALL OPTIONS. Each Portfolio, other than the State Street Global
Advisors Money Market Portfolio, may write covered call options on portfolio
securities to realize a greater current return through the receipt of premiums
than it would realize on portfolio securities alone. Such option transactions
may also be used as a limited form of hedging against a decline in the price of
securities owned by the Portfolio.
A call option gives the holder the right to purchase, and obligates the writer
to sell, a security at the exercise price at any time before the expiration
date. A call option is "covered" if the writer, at all times while obligated as
a writer, either owns the underlying securities (or comparable securities
satisfying the cover requirements of the securities exchanges), or has the right
to acquire such securities through immediate conversion of portfolio securities.
In return for the premium received when it writes a covered call option, the
Portfolio gives up some or all of the opportunity to profit from an increase in
the market price of the securities covering the call option during the life of
the option. The Portfolio retains the risk of loss should the price of such
securities decline. If the option expires unexercised, the Portfolio realizes a
gain equal to the premium, which may be offset by a decline in price of the
underlying security. If the option is exercised, the Portfolio realizes a gain
or loss equal to the difference between the Portfolio's cost for the underlying
security and the proceeds of sale (exercise price minus commissions) plus the
amount of the premium.
A Portfolio may terminate a call option that it has written before it expires by
entering into a closing purchase transaction. A Portfolio may enter into closing
purchase transactions in order to free itself to sell the underlying security or
to write another call on the security, realize a profit on a previously written
call option, or protect a security from being called in an unexpected market
rise. Any profits from a closing purchase transaction may be offset by a decline
in the value of the underlying security. Conversely, because increases in the
market price of a call option will generally reflect increases in the market
price of the underlying security, any loss resulting from a closing purchase
transaction is likely to be offset in whole or in part by unrealized
appreciation of the underlying security owned by the Trust.
COVERED PUT OPTIONS. Each Portfolio, other than the State Street Global
Advisors Money Market Portfolio, may write covered put options in order to
enhance its current return. Such options transactions may also be used as a
limited form of hedging against an increase in the price of securities that the
Portfolio plans to purchase. A put option gives the holder the right to sell,
and obligates the writer to buy, a security at the exercise price at any time
before the expiration date. A put option is "covered" if the writer segregates
cash and high-grade, short-term debt obligations or other permissible collateral
equal to the price to be paid if the option is exercised.
In addition to the receipt of premiums and the potential gains from terminating
such options in closing purchase transactions, the Portfolio also receives
interest on the cash and debt securities maintained to cover the exercise price
of the option. By writing a put option, the Portfolio assumes the risk that it
may be required to purchase the underlying security for an exercise price higher
than its then-current market value, resulting in a potential capital loss,
unless the security later appreciates in value.
A Portfolio may terminate a put option that it has written before it expires by
a closing purchase transaction. Any loss from this transaction may be partially
or entirely offset by the premium received on the terminated option.
PURCHASING PUT AND CALL OPTIONS. Each Portfolio, other than the State
Street Global Advisors Money Market Portfolio, may also purchase put options to
protect portfolio holdings against a decline in market value. This protection
lasts for the life of the put option because the Portfolio, as a holder of the
option, may sell the underlying security at the exercise price, regardless of
any decline in its market price. In order for a put option to be profitable, the
market price of the underlying security must decline sufficiently below the
exercise price to cover the premium and transaction costs that the Portfolio
must pay. These costs will reduce any profit the Portfolio might have realized
had it sold the underlying security instead of buying the put option.
Each Portfolio, other than the State Street Global Advisors Money Market
Portfolio, may purchase call options to hedge against an increase in the price
of securities that the Portfolio ultimately wants to buy. Such hedge protection
is provided during the life of the call option since the Portfolio, as holder of
the call option, is able to buy the underlying security at the exercise price
regardless of any increase in the underlying security's market price. In order
for a call option to be profitable, the market price of the underlying security
must rise sufficiently above the exercise price to cover the premium and
transaction costs. These costs will reduce any profit the Portfolio might have
realized had it bought the underlying security at the time it purchased the call
option.
OPTIONS ON FOREIGN SECURITIES. The Trust may, on behalf of each of the
Portfolios other than the State Street Global Advisors Money Market Portfolio,
purchase and sell options on foreign securities if, in the opinion of the
Sub-Adviser of the particular Portfolio, the investment characteristics of such
options, including the risks of investing in such options, are consistent with
the Portfolio's investment objectives. It is expected that risks related to such
options will not differ materially from risks related to options on U.S.
securities. However, position limits and other rules of foreign exchanges may
differ from those in the United States. In addition, options markets in some
countries, many of which are relatively new, may be less liquid than comparable
markets in the United States.
RISKS INVOLVED IN THE SALE OF OPTIONS. Options transactions involve certain
risks, including the following: (a) that a Portfolio's Sub-Adviser will not
forecast interest rate or market movements correctly; (b) that a Portfolio may
be unable at times to close out such positions; or (c) that hedging transactions
may not accomplish their purpose because of imperfect market correlations. The
successful use of these strategies depends on the ability of a Portfolio's
Sub-Adviser to forecast market and interest rate movements correctly.
An exchange-listed option may be closed out only on an exchange that provides a
secondary market for an option of the same series. There is no assurance that a
liquid secondary market on an exchange will exist for any particular option or
at any particular time. If no secondary market were to exist, it would be
impossible to enter into a closing transaction to close out an option position.
As a result, a Portfolio may be forced to continue to hold, or to purchase at a
fixed price, a security on which it has sold an option at a time when a
Portfolio's Sub-Adviser believes it is inadvisable to do so.
Higher than anticipated trading activity or order flow or other unforeseen
events might cause The Options Clearing Corporation or an exchange to institute
special trading procedures or restrictions that might restrict the Trust's use
of options. The exchanges have established limitations on the maximum number of
calls and puts of each class that may be held or written by an investor or group
of investors acting in concert. It is possible that the Trust and other clients
of a Sub-Adviser may be considered such a group. These position limits may
restrict the Trust's ability to purchase or sell options on particular
securities.
Options which are not traded on national securities exchanges may be closed out
only with the other party to the option transaction. For that reason, it may be
more difficult to close out unlisted options than listed options. Furthermore,
unlisted options are not subject to the protection afforded purchasers of listed
options by The Options Clearing Corporation.
Government regulations, particularly the requirements for qualification as a
"regulated investment company" under the Internal Revenue Code, may also
restrict the Trust's use of options.
FUTURES CONTRACTS
The Trust may, on behalf of each Portfolio that may invest in debt securities,
other than the State Street Global Advisors Money Market Portfolio, buy and sell
futures contracts on debt securities of the type in which the Portfolio may
invest and on indexes of debt securities. In addition, the Trust may, on behalf
of each Portfolio that may invest in equity securities, purchase and sell stock
index futures for hedging and non-hedging purposes. The Trust may also, for
hedging and non-hedging purposes, purchase and write options on futures
contracts of the type that such Portfolios are authorized to buy and sell and
may engage in related closing transactions. All futures and related options
which are traded in the United States will, as may be required by applicable
law, be traded on exchanges that are licensed and regulated by the Commodities
Futures Trading Commission (the "CFTC"). Trading on foreign commodity exchanges
is not regulated by the CFTC.
FUTURES ON DEBT SECURITIES AND RELATED OPTIONS. A futures contract on a
debt security is a binding contractual commitment which, if held to maturity,
will result in an obligation to make or accept delivery during a particular
month of securities having a standardized face value and rate of return. By
purchasing futures on debt securities - assuming a "long" position - the Trust
will legally obligate itself on behalf of the Portfolios to accept the future
delivery of the underlying security and pay the agreed price. By selling futures
on debt securities - assuming a "short" position - it will legally obligate
itself to make the future delivery of the security against payment of the agreed
price. Open futures positions on debt securities will be valued at the most
recent settlement price, unless that price does not, in the judgment of persons
acting at the direction of the Trustees as to the valuation of the Trust's
assets, reflect the fair value of the contract, in which case, the positions
will be valued by or under the direction of the Trustees or such persons.
Positions taken in the futures markets are not normally held to maturity, but
instead are liquidated through offsetting transactions which may result in a
profit or loss. While futures positions taken by the Trust on behalf of a
Portfolio will usually be liquidated in this manner, the Trust may instead make
or take delivery of the underlying securities whenever it appears economically
advantageous to the Portfolio to do so. A clearing corporation associated with
the exchange on which futures are traded assumes responsibility for such closing
transactions and guarantees that the Trust's sale and purchase obligations under
closed-out positions will be performed at the termination of the contract.
Hedging by use of futures on debt securities seeks to establish, more certainly
than would otherwise be possible, the effective rate of return on portfolio
securities. A Portfolio may, for example, take a "short" position in the futures
market by selling contracts for the future delivery of debt securities held by
the Portfolio (or securities having characteristics similar to those held by the
Portfolio) in order to hedge against an anticipated rise in interest rates that
would adversely affect the value of the Portfolio's portfolio securities. When
hedging of this character is successful, any depreciation in the value of
portfolio securities may be substantially offset by appreciation in the value of
the futures position.
On other occasions, the Portfolio may take a "long" position by purchasing
futures on debt securities. This would be done, for example, when the Trust
expects to purchase for the Portfolio particular securities when it has the
necessary cash, but expects the rate of return available in the securities
markets at that time to be less favorable than rates currently available in the
futures markets. If the anticipated rise in the price of the securities should
occur (with its concomitant reduction in yield), the increased cost to the
Portfolio of purchasing the securities may be offset, at least to some extent,
by the rise in the value of the futures position taken in anticipation of the
subsequent securities purchase.
Successful use by the Trust of futures contracts on debt securities is subject
to the ability of a Portfolio's Sub-Adviser to correctly predict movements in
the direction of interest rates and other factors affecting markets for debt
securities. For example, if a Portfolio has hedged against the possibility of an
increase in interest rates which would adversely affect the market prices of
debt securities held by it and the prices of such securities increase instead,
the Portfolio will lose part or all of the benefit of the increased value of its
securities which it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if the Portfolio has
insufficient cash, it may have to sell securities to meet daily maintenance
margin requirements, and thus the Portfolio may have to sell securities at a
time when it may be disadvantageous to do so.
The Trust may purchase and write put and call options on certain debt futures
contracts as they become available. Such options are similar to options on
securities, except that options on futures contracts give the purchaser the
right, in return for the premium paid, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the period of
the option. As with options on securities, the holder or writer of an option may
terminate his position by selling or purchasing an option of the same series.
There is no guarantee that such closing transactions can be effected. The Trust
will be required to deposit initial margin and maintenance margin with respect
to put and call options on futures contracts written by it pursuant to brokers'
requirements, and, in addition, net option premiums received will be included as
initial margin deposits. (See "Margin Payments," below.) Compared to the
purchase or sale of futures contracts, the purchase of call or put options on
futures contracts involves less potential risk to the Trust because the maximum
amount at risk is the premium paid for the options plus transactions costs.
However, there may be circumstances when the purchase of call or put options on
a futures contract would result in a loss to the Trust when the purchase or sale
of the futures contracts would not, such as when there is no movement in the
prices of debt securities. The writing of a put or call option on a futures
contract involves risks similar to those risks relating to the purchase or sale
of futures contracts.
INDEX FUTURES CONTRACTS AND OPTIONS. The Trust may invest in debt index
futures contracts and stock index futures contracts and in related options. A
debt index futures contract is a contract to buy or sell units of a specified
debt index at a specified future date at a price agreed upon when the contract
is made. A unit is the current value of the index. Debt index futures in which
the Trust presently expects to invest are not now available, although the Trust
expects such futures contracts to become available in the future. A stock index
futures contract is a contract to buy or sell units of a stock index at a
specified future date at a price agreed upon when the contract is made. A unit
is the current value of the stock index.
The following example illustrates generally the manner in which index futures
contracts operate. The Standard & Poor's 100 Stock Index (the "S&P 100 Index")
is composed of 100 selected common stocks, most of which are listed on the New
York Stock Exchange (the "NYSE"). The S&P 100 Index assigns relative weightings
to the common stocks included in the S&P 100 Index, and the S&P 100 Index
fluctuates with changes in the market values of those common stocks. In the case
of the S&P 100 Index, contracts are to buy or sell 100 units. Thus, if the value
of the S&P 100 Index were $180, one contract would be worth $18,000 (100 units x
$180). The stock index futures contract specifies that no delivery of the actual
stocks making up the index will take place. Instead, settlement in cash must
occur upon the termination of the contract, with the settlement being the
difference between the contract price and the actual level of the stock index at
the expiration of the contract. For example, if a Portfolio enters into a
futures contract to buy 100 units of the S&P 100 Index at a specified future
date at a contract price of $180 and the S&P 100 Index is at $184 on that future
date, the Portfolio will gain $400 (100 units x gain of $4). If the Portfolio
enters into a futures contract to sell 100 units of the stock index at a
specified future date at a contract price of $180 and the S&P 100 Index is at
$182 on that future date, the Portfolio will lose $200 (100 units x loss of $2).
The Trust does not presently expect to invest in debt index futures contracts.
Stock index futures contracts are currently traded with respect to the S&P 100
Index on the Chicago Mercantile Exchange, and with respect to other broad stock
market indexes, such as the New York Stock Exchange Composite Stock Index, which
is traded on the New York Futures Exchange, and the Value Line Composite Stock
Index, which is traded on the Kansas City Board of Trade, as well as with
respect to narrower "sub-indexes" such as the S&P 100 Energy Stock Index and the
New York Stock Exchange Utilities Stock Index. To the extent permitted under
applicable law, a Portfolio may trade futures contracts and options on futures
contracts on exchanges created outside the United States, such as the London
International Financial Futures Exchange and the Sydney Futures Exchange
Limited. Foreign markets may offer advantages such as trading in commodities
that are not currently traded in the United States or arbitrage possibilities
not available in the United States. Foreign markets, however, may have greater
risk potential than domestic markets. A Portfolio may purchase or sell futures
contracts with respect to any stock. Positions in index futures may be closed
out only on an exchange or board of trade which provides a secondary market for
such futures.
In order to hedge a Portfolio's investments successfully using futures contracts
and related options, the Trust must invest in futures contracts with respect to
indexes or sub-indexes, the movements of which will, in its judgment, have a
significant correlation with movements in the prices of the Portfolio's
securities. Options on index futures contracts are similar to options on
securities except that options on index futures contracts give the purchaser the
right, in return for the premium paid, to assume a position in an index futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the period of
the option. Upon exercise of the option, the holder would assume the underlying
futures position and would receive a variation margin payment of cash or
securities approximating the increase in the value of the holder's option
position. If an option is exercised on the last trading day prior to the
expiration date of the option, the settlement will be made entirely in cash
based on the difference between the exercise price of the option and the closing
level of the index on which the futures contract is based on the expiration
date. Purchasers of options who fail to exercise their options prior to the
exercise date suffer a loss of the premium paid.
As an alternative to purchasing and selling call and put options on index
futures contracts, each of the Portfolios that may purchase and sell index
futures contracts may purchase and sell call and put options on the underlying
indexes themselves to the extent that such options are traded on national
securities exchanges. Index options are similar to options on individual
securities in that the purchaser of an index option acquires the right to buy
(in the case of a call) or sell (in the case of a put), and the writer
undertakes the obligation to sell or buy (as the case may be), units of an index
at a stated exercise price during the term of the option. Instead of giving the
right to take or make actual delivery of securities, the holder of an index
option has the right to receive a cash "exercise settlement amount." This amount
is equal to the amount by which the fixed exercise price of the option exceeds
(in the case of a put) or is less than (in the case of a call) the closing value
of the underlying index on the date of the exercise, multiplied by a fixed
"index multiplier."
A Portfolio may purchase or sell options on stock indexes in order to close out
its outstanding positions in options on stock indexes that it has purchased. A
Portfolio may also allow such options to expire unexercised.
Compared to the purchase or sale of futures contracts, the purchase of call or
put options on an index involves less potential risk to the Trust because the
maximum amount at risk is the premium paid for the options plus transactions
costs. The writing of a put or call option on an index involves risks similar to
those risks relating to the purchase or sale of index futures contracts.
MARGIN PAYMENTS. When a Portfolio purchases or sells a futures contract, it
is required to deposit with the Custodian an amount of cash, U.S. Treasury
bills, or other permissible collateral equal to a small percentage of the amount
of the futures contract. This amount is known as "initial margin." The nature of
initial margin is different from that of margin in security transactions in that
it does not involve borrowing money to finance transactions. Rather, initial
margin is similar to a performance bond or good faith deposit that is returned
to the Trust upon termination of the contract, assuming the Trust satisfies its
contractual obligations.
Subsequent payments to and from the broker occur on a daily basis in a process
known as "marking to market." These payments are called "variation margin" and
are made as the value of the underlying futures contract fluctuates. For
example, when a Portfolio sells a futures contract and the price of the
underlying debt security rises above the delivery price, the Portfolio's
position declines in value. The Portfolio then pays the broker a variation
margin payment equal to the difference between the delivery price of the futures
contract and the market price of the securities underlying the futures contract.
Conversely, if the price of the underlying security falls below the delivery
price of the contract, the Portfolio's futures position increases in value. The
broker then must make a variation margin payment equal to the difference between
the delivery price of the futures contract and the market price of the
securities underlying the futures contract.
When a Portfolio terminates a position in a futures contract, a final
determination of variation margin is made, additional cash is paid by or to the
Portfolio, and the Portfolio realizes a loss or a gain. Such closing
transactions involve additional commission costs.
SPECIAL RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS LIQUIDITY
RISKS. Positions in futures contracts may be closed out only on an exchange or
board of trade which provides a secondary market for such futures. Although the
Trust 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 or at any particular time. If there is not a liquid
secondary market at a particular time, it may not be possible to close a futures
position at such time and, in the event of adverse price movements, the Trust
would continue to be required to make daily cash payments of variation margin.
However, in the event financial futures are used to hedge portfolio securities,
such securities will not generally be sold until the financial futures can be
terminated. In such circumstances, an increase in the price of the portfolio
securities, if any, may partially or completely offset losses on the financial
futures.
In addition to the risks that apply to all options transactions, there are
several special risks relating to options on futures contracts. The ability to
establish and close out positions in such options will be subject to the
development and maintenance of a liquid secondary market. It is not certain that
such a market will develop. Although the Trust generally will purchase only
those options for which there appear to be an active secondary market, there is
no assurance that a liquid secondary market on an exchange will exist for any
particular option or at any particular time. In the event that no such market
exists for particular options, it might not be possible to effect closing
transactions in such options with the result that the Trust would have to
exercise the options in order to realize any profit.
HEDGING RISKS. There are several risks in connection with the use by a
Portfolio of futures contracts and related options as a hedging device. One risk
arises because of the imperfect correlation between movements in the prices of
the futures contracts and options and movements in the underlying securities or
index or movements in the prices of the Trust's securities which are the subject
of the hedge. A Portfolio's Sub-Adviser will, however, attempt to reduce this
risk by purchasing and selling, to the extent possible, futures contracts and
related options on securities and indexes, the movements of which will, in its
judgment, correlate closely with movements in the prices of the underlying
securities or index and the Trust's portfolio securities sought to be hedged.
Successful use of futures contracts and options by a Portfolio for hedging
purposes is also subject to a Portfolio's Sub-Adviser's ability to correctly
predict movements in the direction of the market. It is possible that, where a
Portfolio has purchased puts on futures contracts to hedge its portfolio against
a decline in the market, the securities or index on which the puts are purchased
may increase in value and the value of securities held in the Portfolio may
decline. If this occurred, the Portfolio would lose money on the puts and also
experience a decline in value in its portfolio securities. In addition, the
prices of futures, for a number of reasons, may not correlate perfectly with
movements in the underlying securities or index due to certain market
distortions. First, all participants in the futures market are subject to margin
deposit requirements. Such requirements may cause investors to close futures
contracts through offsetting transactions which could distort the normal
relationship between the underlying security or index and futures markets.
Second, the margin requirements in the futures markets are less onerous than
margin requirements in the securities markets in general, and as a result, the
futures markets may attract more speculators than the securities markets.
Increased participation by speculators in the futures markets may also cause
temporary price distortions. Due to the possibility of price distortion, even a
correct forecast of general market trends by a Portfolio's Sub-Adviser still may
not result in a successful hedging transaction over a very short time period.
FOREIGN TRANSACTION RISKS. Unlike trading on domestic commodity exchanges,
trading on foreign commodity exchanges is not regulated by the CFTC and may be
subject to greater risks than trading on domestic exchanges. For example, some
foreign exchanges are principal markets so that no common clearing facility
exists and a trader may look only to the broker for performance of the contract.
In addition, unless a Portfolio hedges against fluctuations in the exchange rate
between the U.S. dollar and the currencies in which trading is done on foreign
exchanges, any profits that the Portfolio might realize in trading could be
eliminated by adverse changes in the exchange rate, or the Portfolio could incur
losses as a result of those changes. Transactions on foreign exchanges may
include both commodities which are traded on domestic exchanges and those which
are not.
OTHER RISKS. Portfolios will incur brokerage fees in connection with their
futures and options transactions. In addition, while futures contracts and
options on futures will be purchased and sold to reduce certain risks, those
transactions themselves entail certain other risks. Thus, while a Portfolio may
benefit from the use of futures and related options, unanticipated changes in
interest rates or stock price movements may result in a poorer overall
performance for the Portfolio than if it had not entered into any futures
contracts or options transactions. Moreover, in the event of an imperfect
correlation between the futures position and the portfolio position which is
intended to be protected, the desired protection may not be obtained and the
Portfolio may be exposed to risk of loss.
FORWARD COMMITMENTS
The Trust may, on behalf of each Portfolio, enter into contracts to purchase
securities for a fixed price at a future date beyond customary settlement time
("forward commitments") if the Portfolio holds, and maintains until the
settlement date in a segregated account maintained by the Custodian with assets
selected by the Custodian, cash or high-grade debt obligations in an amount
sufficient to meet the purchase price, or if the Portfolio enters into
offsetting contracts for the forward sale of other securities it owns. Forward
commitments may be considered securities in themselves, and involve a risk of
loss if the value of the security to be purchased declines prior to the
settlement date, which risk is in addition to the risk of decline in the value
of the Portfolio's other assets. Where such purchases are made through dealers,
the Portfolio relies on the dealer to consummate the sale. The dealer's failure
to do so may result in the loss to the Portfolio of an advantageous yield or
price.
Although a Portfolio will generally enter into forward commitments with the
intention of acquiring securities for its portfolio or for delivery pursuant to
options contracts it has entered into, a Portfolio may dispose of a commitment
prior to settlement if a Portfolio's Sub-Adviser deems it appropriate to do so.
A Portfolio may realize short-term profits or losses upon the sale of forward
commitments.
REPURCHASE AGREEMENTS
On behalf of each Portfolio, the Trust may enter into repurchase agreements. A
repurchase agreement is a contract under which the Portfolio acquires a security
for a relatively short period (usually not more than one week) subject to the
obligation of the seller to repurchase and the Portfolio to resell such security
at a fixed time and price (representing the Portfolio's cost plus interest). It
is the Trust's present intention to enter into repurchase agreements only with
member banks of the Federal Reserve System and securities dealers meeting
certain criteria as to creditworthiness and financial condition established by
the Trustees of the Trust and only with respect to obligations of the U.S.
government or its agencies or instrumentalities or other high-quality,
short-term debt obligations. Repurchase agreements may also be viewed as loans
made by the Trust which are collateralized by the securities subject to
repurchase. The Sub-Advisers will monitor such transactions to ensure that the
value of the underlying securities will be at least equal at all times to the
total amount of the repurchase obligation, including the interest factor. If the
seller defaults, the Trust could realize a loss on the sale of the underlying
security to the extent that the proceeds of sale, including accrued interest,
are less than the resale price provided in the agreement including interest. In
addition, if the seller should be involved in bankruptcy or insolvency
proceedings, the Trust may incur delay and costs in selling the underlying
security or may suffer a loss of principal and interest if the Trust is treated
as an unsecured creditor and required to return the underlying collateral to the
seller's estate.
REVERSE REPURCHASE AGREEMENTS
The Trust may, on behalf of each of the Portfolios, enter into reverse
repurchase agreements, which involve the sale by the Portfolio of securities
held by it with an agreement to repurchase the securities at an agreed upon
price, date, and interest payment. The Portfolios will use the proceeds of the
reverse repurchase agreements to purchase securities either maturing, or under
an agreement to resell, at a date simultaneous with or prior to the expiration
of the reverse repurchase agreement. A Portfolio will use reverse repurchase
agreements when the interest income to be earned from the investment of the
proceeds of the transaction is greater than the interest expense of the reverse
repurchase transaction. Reverse repurchase agreements into which the Portfolios
will enter require that the market value of the underlying security and other
collateral equal or exceed the repurchase price (including interest accrued on
the security), and require the Portfolios to provide additional collateral if
the market value of such security falls below the repurchase price at any time
during the term of the reverse repurchase agreement. At all times that a reverse
repurchase agreement is outstanding, the Portfolio will maintain cash, liquid
high-grade debt obligations, or U.S. government securities, as the case may be,
in a segregated account at its custodian with a value at least equal to its
obligations under the agreement.
WHEN-ISSUED SECURITIES
The Trust may, on behalf of each Portfolio, from time to time purchase
securities on a "when-issued" basis. Debt securities are often issued on this
basis. The price of such securities, which may be expressed in yield terms, is
fixed at the time a commitment to purchase is made, but delivery and payment for
the when-issued securities take place at a later date. Normally, the settlement
date occurs within one month of the purchase. During the period between purchase
and settlement, no payment is made by a Portfolio and no interest accrues to the
Portfolio. To the extent that assets of a Portfolio are held in cash pending the
settlement of a purchase of securities, that Portfolio would earn no income.
While the Trust may sell its right to acquire when-issued securities prior to
the settlement date, the Trust intends actually to acquire such securities
unless a sale prior to settlement appears desirable for investment reasons. At
the time a Portfolio makes the commitment to purchase a security on a
when-issued basis, it will record the transaction and reflect the amount due and
the value of the security in determining the Portfolio's net asset value. The
market value of the when-issued securities may be more or less than the purchase
price payable at the settlement date. Each Portfolio will establish a segregated
account in which it will maintain cash and U.S. government securities or other
high-grade debt obligations at least equal in value to commitments for
when-issued securities. Such segregated securities either will mature or, if
necessary, be sold on or before the settlement date.
LOANS OF PORTFOLIO SECURITIES
The Trust may lend the portfolio securities of any Portfolio, provided: (a) the
loan is secured continuously by collateral consisting of U.S. government
securities, cash, or cash equivalents adjusted daily to have market value at
least equal to the current market value of the securities loaned; (b) the Trust
may, at any time, call the loan and regain the securities loaned; (c) the Trust
will receive any interest or dividends paid on the loaned securities; and (d)
the aggregate market value of securities of any Portfolio loaned will not, at
any time, exceed 20% (except 10% with respect to the EliteValue Portfolio, 15%
with respect to the Credit Suisse International Equity Portfolio, and 33 1/3%
with respect to the State Street Global Advisors Money Market Portfolio and the
State Street Global Advisors Growth Equity Portfolio) of the total assets of the
Portfolio taken at value. In addition, it is anticipated that the Portfolio may
share with the borrower some of the income received on the collateral for the
loan or that it will be paid a premium for the loan. Before the Portfolio enters
into a loan, a Portfolio's Sub-Adviser considers all relevant facts and
circumstances including the creditworthiness of the borrower. The risks in
lending portfolio securities, as with other extensions of credit, consist of
possible delay in recovery of the securities or possible loss of rights in the
collateral should the borrower fail financially. Although voting rights, or
rights to consent, with respect to the loaned securities pass to the borrower,
the Trust retains the right to call the loans at any time on reasonable notice,
and it will do so in order that the securities may be voted by the Trust if the
holders of such securities are asked to vote upon or consent to matters
materially affecting the investment. The Trust will not lend portfolio
securities to borrowers affiliated with the Trust.
FOREIGN SECURITIES
Investments in foreign securities may involve considerations different from
investments in domestic securities due to limited publicly available
information, non-uniform accounting standards, lower trading volume and possible
consequent illiquidity, greater volatility in price, the possible imposition of
withholding or confiscatory taxes, the possible adoption of foreign governmental
restrictions affecting the payment of principal and interest, expropriation of
assets, nationalization, or other adverse political or economic developments.
Foreign companies may not be subject to auditing and financial reporting
standards and requirements comparable to those which apply to U.S. companies.
Foreign brokerage commissions and other fees are generally higher than in the
United States. It may also be more difficult to obtain and enforce a judgment
against a foreign issuer.
In addition, to the extent that any Portfolio's foreign investments are not U.S.
dollar-denominated, the Portfolio may be affected favorably or unfavorably by
changes in currency exchange rates or exchange control regulations and may incur
costs in connection with conversion between currencies.
In determining whether to invest in securities of foreign issuers, the
Sub-Adviser of a Portfolio will consider the likely effect of foreign taxes on
the net yield available to the Portfolio and its shareholders. Income received
by a Portfolio from sources within foreign countries may be reduced by
withholding and other taxes imposed by such countries. Tax conventions between
certain countries and the United States may reduce or eliminate such taxes. It
is impossible to determine the effective rate of foreign tax in advance, since
the amount of a Portfolio's assets to be invested in various countries is not
known, and tax laws and their interpretations may change from time to time and
without advance notice. Any such taxes paid by a Portfolio will reduce its net
income available for distribution to shareholders.
FOREIGN CURRENCY TRANSACTIONS
The Trust may engage in currency exchange transactions, on behalf of its
Portfolios which may invest in foreign securities, to protect against
uncertainty in the level of future foreign currency exchange rates and to
increase current return. The Trust may engage in both "transaction hedging" and
"position hedging."
When it engages in transaction hedging, the Trust enters into foreign currency
transactions with respect to specific receivables or payables of a Portfolio
generally arising in connection with the purchase or sale of its portfolio
securities. The Trust will engage in transaction hedging when it desires to
"lock-in" the U.S. dollar price of a security it has agreed to purchase or sell,
or the U.S. dollar equivalent of a dividend or interest payment in a foreign
currency. By transaction hedging, the Trust will attempt to protect a Portfolio
against a possible loss resulting from an adverse change in the relationship
between the U.S. dollar and the applicable foreign currency during the period
between the date on which the security is purchased or sold or on which the
dividend or interest payment is declared and the date on which such payments are
made or received.
The Trust may purchase or sell a foreign currency on a spot (or cash) basis at
the prevailing spot rate in connection with transaction hedging. The Trust may
also enter into contracts to purchase or sell foreign currencies at a future
date ("forward contracts") and purchase and sell foreign currency futures
contracts.
For transaction hedging purposes, the Trust may also purchase exchange-listed
and over-the-counter call and put options on foreign currency futures contracts
and on foreign currencies. A put option on a futures contract gives the Trust
the right to assume a short position in the futures contract until expiration of
the option. A put option on currency gives the Trust the right to sell a
currency at an exercise price until the expiration of the option. A call option
on a futures contract gives the Trust the right to assume a long position in the
futures contract until the expiration of the option. A call option on currency
gives the Trust the right to purchase a currency at the exercise price until the
expiration of the option. The Trust will engage in over-the-counter transactions
only when appropriate exchange-traded transactions are unavailable and when, in
the opinion of the Portfolio's Sub-Adviser, the pricing mechanism and liquidity
are satisfactory and the participants are responsible parties likely to meet
their contractual obligations.
When it engages in position hedging, the Trust enters into foreign currency
exchange transactions to protect against a decline in the values of the foreign
currencies in which securities held by a Portfolio are denominated or are quoted
in their principal trading markets or an increase in the value of currency for
securities that a Portfolio expects to purchase. In connection with position
hedging, the Trust may purchase put or call options on foreign currency and
foreign currency futures contracts and buy or sell forward contracts and foreign
currency futures contracts. The Trust may also purchase or sell foreign currency
on a spot basis.
The precise matching of the amounts of foreign currency exchange transactions
and the value of the portfolio securities involved will not generally be
possible since the future value of such securities in foreign currencies will
change as a consequence of market movements in the values of those securities
between the dates the currency exchange transactions are entered into and the
dates they mature.
It is impossible to forecast with precision the market value of a Portfolio's
portfolio securities at the expiration or maturity of a forward or futures
contract. Accordingly, it may be necessary for the Trust to purchase additional
foreign currency on behalf of a Portfolio on the spot market (and bear the
expense of such purchase) if the market value of the security or securities
being hedged is less than the amount of foreign currency the Trust is obligated
to deliver and if a decision is made to sell the security or securities 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 or securities of a Portfolio if the market value of such security or
securities exceeds the amount of foreign currency the Trust is obligated to
deliver on behalf of the Portfolio.
To offset some of the costs to a Portfolio of hedging against fluctuations in
currency exchange rates, the Trust may write covered call options on those
currencies.
Transaction and position hedging do not eliminate fluctuations in the underlying
prices of the securities which a Portfolio owns or intends to purchase or sell.
They simply establish a rate of exchange that one can achieve at some future
point in time.
Additionally, although these techniques tend to minimize the risk of loss due to
a decline in the value of the hedged currency, they tend to limit any potential
gain which might result from the increase in the value of such currency.
A Portfolio may also seek to increase its current return by purchasing and
selling foreign currency on a spot basis, and by purchasing and selling options
on foreign currencies and on foreign currency futures contracts, and by
purchasing and selling foreign currency forward contracts.
CURRENCY FORWARD AND FUTURES CONTRACTS. 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
as agreed by the parties, at a price set at the time of the contract. In the
case of a cancelable forward contract, the holder has the unilateral right to
cancel the contract at maturity by paying a specified fee. The 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 charged at any
stage for trades. A foreign currency futures contract is a standardized contract
for the future delivery of a specified amount of a foreign currency at a future
date at a price set at the time of the contract. Foreign currency futures
contracts traded in the United States are designed by and traded on exchanges
regulated by the CFTC, such as the New York Mercantile Exchange.
Forward foreign currency exchange contracts differ from foreign currency futures
contracts in certain respects. For example, the maturity date of a forward
contract may be any fixed number of days from the date of the contract agreed
upon by the parties, rather than a predetermined date in a given month. Forward
contracts may be in any amounts agreed upon by the parties rather than
predetermined amounts. Also, forward foreign exchange contracts are traded
directly between currency traders so that no intermediary is required. A forward
contract generally requires no margin or other deposit.
At the maturity of a forward or futures contract, the Trust may either accept or
make delivery of the currency specified in the contract, or at or prior to
maturity, enter into a closing transaction involving the purchase or sale of an
offsetting contract. Closing transactions with respect to forward contracts are
usually effected with the currency trader who is a party to the original forward
contract. Closing transactions with respect to futures contracts are effected on
a commodities exchange; a clearing corporation associated with the exchange
assumes responsibility for closing out such contracts.
Positions in foreign currency futures contracts and related options may be
closed out only on an exchange or board of trade which provides a secondary
market in such contracts or options. Although the Trust intends to purchase or
sell foreign currency futures contracts and related options only on exchanges or
boards of trade where there appear to be active secondary markets, there is no
assurance that a secondary market on an exchange or board of trade will exist
for any particular contract or option or at any particular time. In such event,
it may not be possible to close a futures or related option position and, in the
event of adverse price movements, the Trust would continue to be required to
make daily cash payments of variation margin on its futures positions.
FOREIGN CURRENCY OPTIONS. Options on foreign currencies operate similarly
to options on securities, and are traded primarily in the over-the-counter
market, although options on foreign currencies have recently been listed on
several exchanges. Such options will be purchased or written only when a
Portfolio's Sub-Adviser believes that a liquid secondary market exists for such
options. There can be no assurance that a liquid secondary market will exist for
a particular option at any specific time. Options on foreign currencies are
affected by all of those factors which influence exchange rates and investments
generally.
The value of a foreign currency option is dependent upon the value of the
foreign currency and the U.S. dollar and may have no relationship to the
investment merits of a foreign security. Because foreign currency transactions
occurring in the interbank market involve substantially larger amounts than
those that may be involved in the use of foreign currency options, investors may
be disadvantaged by having to deal in an odd lot market (generally consisting of
transactions of less than $1 million) for the underlying foreign currencies at
prices that are less favorable than for round lots.
There is no systematic reporting of last sale information for foreign currencies
and there is no regulatory requirement that quotations available through dealers
or other market sources be firm or revised on a timely basis. Available
quotation information is generally representative of very large transactions in
the interbank market and thus may not reflect relatively smaller transactions
(less than $1 million) where rates may be less favorable. The interbank market
in foreign currencies is a global, around-the-clock market. To the extent that
the U.S. options markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may take place in
the underlying markets that cannot be reflected in the U.S. options markets.
FOREIGN CURRENCY CONVERSION. Although foreign exchange dealers do not
charge a fee for currency conversion, they do realize a profit based on the
difference (the "spread") between prices at which they buy and sell various
currencies. Thus, a dealer may offer to sell a foreign currency to the Trust at
one rate, while offering a lesser rate of exchange should the Trust desire to
resell that currency to the dealer.
SWAPS, CAPS, FLOORS, AND COLLARS. Among the strategic transactions into
which certain Portfolios may enter are interest rate, currency and index swaps,
and other types of available swap agreements, such as caps, floors, and collars.
A Portfolio will enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio, to protect
against currency fluctuations, as a duration management technique, or to protect
against any increase in the price of securities a Portfolio anticipates
purchasing at a later date. A Portfolio will use these transactions as hedges
and not as speculative investments and will not sell interest rate caps or
floors where it does not own securities or other instruments providing the
income stream the Portfolio may be obligated to pay. Interest rate swaps involve
the exchange by the Portfolio with another party of their respective commitments
to pay or receive interest, (e.g., an exchange of floating rate payments for
fixed rate payments) with respect to a notional amount of principal. A currency
swap is an agreement to exchange cash flows on a notional amount of two or more
currencies based on the relative value differential among them. An index swap is
an agreement to swap cash flows on a notional amount based on changes in the
values of the reference indices. The purchase of a cap entitles the purchaser to
receive payments on a notional principal amount from the party selling such cap
to the extent that a specified index exceeds a predetermined interest rate or
amount. The purchase of a floor entitles the purchaser to receive payments on a
notional principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount. A collar is
a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
A Portfolio will usually enter into swaps on a net basis (i.e., the two payment
streams are netted out in a cash settlement on the payment date or dates
specified in the instrument) with the Portfolio receiving or paying, as the case
may be, only the net amount of the two payments. Inasmuch as these swaps, caps,
floors, and collars are entered into for good faith hedging purposes, the
Sub-Advisers and the Portfolios believe such obligations do not constitute
senior securities under the Investment Company Act of 1940 (the "1940 Act"), as
amended, and accordingly, will not treat them as being subject to its borrowing
restrictions. If there is a default by the counterparty, the Portfolio may have
contractual remedies pursuant to the agreements related to the transaction. The
swap market has grown substantially in recent years with a large number of banks
and investment banking firms acting as both principals and agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps, floors, and collars are more recent innovations for
which standardized documentation has not yet been fully developed and
accordingly, they are less liquid than swaps.
With respect to swaps, the Portfolio will accrue the net amount of the excess,
if any, of its obligations over its entitlements with respect to each swap on a
daily basis and will segregate with its custodian an amount of cash or liquid
high-grade securities having a value equal to the accrued excess. Caps, floors,
and collars require segregation of assets with a value equal to a Portfolio's
net obligation, if any.
COMMERCIAL MORTGAGE-BACKED SECURITIES
A Portfolio may invest in commercial mortgage-backed securities. Commercial
mortgage-backed securities are generally multi-class debt or pass-through
securities backed by a mortgage loan or pool of mortgage loans secured by
commercial property, such as industrial and warehouse properties, office
buildings, retail space and shopping malls, multi-family properties and
cooperative apartments, hotels and motels, nursing homes, hospitals, senior
living centers, and agricultural property. The commercial mortgage loans that
underlie commercial mortgage-backed securities have certain distinct
characteristics. Commercial mortgage loans are generally not amortizing or not
fully amortizing. At their maturity date, repayment of the remaining principal
balance or "balloon" is due and is repaid through the attainment of an
additional loan or sale of the property. Unlike most single-family residential
mortgages, commercial real property loans often contain provisions which
substantially reduce the likelihood that such securities will be prepaid. The
provisions generally impose significant prepayment penalties on loans and, in
some cases, there may be prohibitions on principal prepayments for several years
following origination. This difference in prepayment exposure is significant due
to extraordinarily high levels of refinancing of traditional residential
mortgages experienced over the past year as mortgage rates have reached a
25-year low. Assets underlying commercial mortgage-backed securities may relate
to only a few properties or to a single property.
Commercial mortgage-backed securities have been issued in public and private
transactions by a variety of public and private issuers. Non-governmental
entities that have issued or sponsored commercial mortgage-backed securities
offerings include owners of commercial properties, originators of and investors
in mortgage loans, savings and loan associations, mortgage banks, commercial
banks, insurance companies, investment banks, and special-purpose subsidiaries
of the foregoing. The BlackRock Managed Bond Portfolio may, from time to time,
purchase commercial mortgage-backed securities directly from issuers in
negotiated transactions or from a holder of such commercial mortgage-backed
securities in the secondary market.
Commercial mortgage-backed securities generally are structured to protect the
senior class investors against potential losses on the underlying mortgage
loans. This is generally provided by the subordinated class investors, which may
be included in the Portfolio, by taking the first loss if there are defaults on
the underlying commercial mortgage loans. Other protection, which may benefit
all of the classes, including the subordinated classes in which the Portfolio
intends to invest, may include issuer guarantees, reserve funds, additional
subordinated securities, cross-collateralization, over-collateralization, and
the equity investors in the underlying properties.
By adjusting the priority of interest and principal payments on each class of a
given commercial mortgage-backed security, issuers are able to issue senior
investment-grade securities and lower-rated or non-rated subordinated securities
tailored to meet the needs of sophisticated institutional investors. In general,
subordinated classes of commercial mortgage-backed securities are entitled to
receive repayment of principal only after all required principal payments have
been made to more senior classes and have subordinate rights as to receipt of
interest distributions. Such subordinated classes are subject to a substantially
greater risk of nonpayment than are senior classes of commercial mortgage-backed
securities. Even within a class of subordinate securities, most commercial
mortgage-backed securities are structured with a hierarchy of levels (or "loss
positions"). Loss positions are the order in which nonrecoverable losses of
principal are applied to the securities within a given structure. For instance,
a first-loss subordinate security will absorb any principal losses before any
higher-loss position subordinate security. This type of structure allows a
number of classes of securities to be created with varying degrees of credit
exposure, prepayment exposure, and potential total return.
Subordinated classes of commercial mortgage-backed securities have more recently
been structured to meet specific investor preferences and issuer constraints and
have different priorities for cash flow and loss absorption. As previously
discussed, from a credit perspective, they are structured to absorb any
credit-related losses prior to the senior class. The principal cash flow
characteristics of subordinated classes are designed to be among the most stable
in the mortgage-backed securities market, the probability of prepayment being
much lower than with traditional residential mortgage-backed securities. This
characteristic is primarily due to the structural feature that directs the
application of principal payments first to the senior classes until they are
retired before the subordinated classes receive any prepayments. While this
serves to enhance the credit protection of the senior classes, it produces
subordinated classes with more stable average lives. Subject to the applicable
provisions of the 1940 Act, there are no limitations on the classes of
commercial mortgage-backed securities in which the Portfolio may invest.
Accordingly, in certain circumstances, the Portfolio may recover proportionally
less of its investment in a commercial mortgage-backed security than the holders
of more senior classes of the same commercial mortgage-backed security.
The rating assigned to a given issue and class of commercial mortgage-backed
securities is a product of many factors, including the structure of the
security, the level of subordination, the quality and adequacy of the
collateral, and the past performance of the originators and servicing companies.
The rating of any commercial mortgage-backed security is determined to a
substantial degree by the debt service coverage ratio (i.e., the ratio of
current net operating income from the commercial properties, in the aggregate,
to the current debt service obligations on the properties) and the loan-to-value
(the "LTV") ratio of the pooled properties. The amount of the securities issued
in any one rating category is determined by the rating agencies after a rigorous
credit rating process which includes analysis of the issuer, servicer, and
property manager, as well as verification of the LTV and debt service coverage
ratios. LTV ratios may be particularly important in the case of commercial
mortgages because most commercial mortgage loans provide that the lender's sole
remedy in the event of a default is against the mortgaged property, and the
lender is not permitted to pursue remedies with respect to other assets of the
borrower. Accordingly, LTV ratios may, in certain circumstances, determine the
amount realized by the holder of the commercial mortgage-backed security.
ZERO-COUPON SECURITIES
Zero-coupon securities in which a Portfolio may invest are debt obligations
which are generally issued at a discount and payable in full at maturity, and
which do not provide for current payments of interest prior to maturity.
Zero-coupon securities usually trade at a deep discount from their face or par
value and are subject to greater market value fluctuations from changing
interest rates than debt obligations of comparable maturities which make current
distributions of interest. As a result, the net asset value of shares of a
Portfolio investing in zero-coupon securities may fluctuate over a greater range
than shares of other Portfolios of the Trust and other mutual funds investing in
securities making current distributions of interest and having similar
maturities.
Zero-coupon securities may include U.S. Treasury bills issued directly by the
U.S. Treasury or other short-term debt obligations, and longer-term bonds or
notes and their unmatured interest coupons which have been separated by their
holder, typically a custodian bank or investment brokerage firm. A number of
securities firms and banks have stripped the interest coupons from the
underlying principal (the "corpus") of U.S. Treasury securities and resold them
in custodial receipt programs with a number of different names, including
Treasury Income Growth Receipts ("TIGRS") and Certificates of Accrual on
Treasuries ("CATS"). The underlying U.S. Treasury bonds and notes themselves are
held in book-entry form at the Federal Reserve Bank or, in the case of bearer
securities (i.e., unregistered securities which are owned ostensibly by the
bearer or holder thereof), in trust on behalf of the owners thereof.
In addition, the Treasury has facilitated transfers of ownership of zero-coupon
securities by accounting separately for the beneficial ownership of particular
interest coupons and corpus payments on Treasury securities through the Federal
Reserve book-entry recordkeeping system. The Federal Reserve program, as
established by the Treasury Department, is known as "STRIPS" or "Separate
Trading of Registered Interest and Principal of Securities." Under the STRIPS
program, a Portfolio will be able to have its beneficial ownership of U.S.
Treasury zero-coupon securities recorded directly in the book-entry
recordkeeping system in lieu of having to hold certificates or other evidences
of ownership of the underlying U.S. Treasury securities.
When debt obligations have been stripped of their unmatured interest coupons by
the holder, the stripped coupons are sold separately. The principal or corpus is
sold at a deep discount because the buyer only receives the right to receive a
future fixed payment on the security and does not receive any rights to periodic
cash interest payments. Once stripped or separated, the corpus and coupons may
be sold separately. Typically, the coupons are sold separately or grouped with
other coupons with like maturity dates and sold in such bundled form. Purchasers
of stripped obligations acquire, in effect, discount obligations that are
economically identical to the zero-coupon securities issued directly by the
obligor.
VARIABLE- OR FLOATING-RATE SECURITIES
Certain Portfolios may invest in securities which offer a variable or floating
rate of interest. Variable-rate securities provide for automatic establishment
of a new interest rate at fixed intervals (e.g., daily, monthly, semi-annually,
etc.). Floating-rate securities provide for automatic adjustment of the interest
rate whenever some specified interest rate index changes. The interest rate on
variable- or floating-rate securities is ordinarily determined by reference to,
or is a percentage of, a bank's prime rate, the 90-day U.S. Treasury bill rate,
the rate of return on commercial paper or bank certificates of deposit, an index
of short-term interest rates, or some other objective measure.
Variable- or floating-rate securities frequently include a demand feature
entitling the holder to sell the securities to the issuer at par. In many cases,
the demand feature can be exercised at any time on seven days' notice; in other
cases, the demand feature is exercisable at any time on 30 days' notice or on
similar notice at intervals of not more than one year. Some securities which do
not have variable or floating interest rates may be accompanied by puts
producing similar results and price characteristics.
Variable-rate demand notes include master demand notes which are obligations
that permit a Portfolio to invest fluctuating amounts, which may change daily
without penalty, pursuant to direct arrangements between the Portfolio as lender
and the borrower. The interest rates on these notes fluctuate from time to time.
The issuer of such obligations normally has a corresponding right, after a given
period, to prepay, in its discretion, the outstanding principal amount of the
obligations plus accrued interest upon a specified number of days' notice to the
holders of such obligations. The interest rate on a floating-rate demand
obligation is based on a known lending rate, such as a bank's prime rate, and is
adjusted automatically each time such rate is adjusted. The interest rate on a
variable-rate demand obligation is adjusted automatically at specified
intervals. Frequently, such obligations are secured by letters of credit or
other credit support arrangements provided by banks. Because these obligations
are direct lending arrangements between the lender and borrower, it is not
contemplated that such instruments will generally be traded, and there generally
is not an established secondary market for these obligations, although they are
redeemable at face value. Accordingly, where these obligations are not secured
by letters of credit or other credit support arrangements, the Portfolio's right
to redeem is dependent on the ability of the borrower to pay principal and
interest on demand. Such obligations frequently are not rated by credit rating
agencies. If not so rated, a Portfolio may invest in them only if the
Portfolio's Sub-Adviser determines that, at the time of investment, the
obligations are of comparable quality to the other obligations in which the
Portfolio may invest. The Sub-Adviser, on behalf of a Portfolio, will consider
on an ongoing basis the creditworthiness of the issuers of the floating- and
variable-rate demand obligations in the Portfolio's portfolio.
LOWER-GRADE SECURITIES
Certain Portfolios may invest in lower-grade income securities. Such lower-grade
securities are commonly referred to as "junk bonds." Investment in such
securities involves special risks, as described herein. Liquidity relates to the
ability of a Portfolio to sell a security in a timely manner at a price which
reflects the value of that security. As discussed below, the market for
lower-grade securities is generally considered to be less liquid than the market
for investment-grade securities. The relative illiquidity of some of a
Portfolio's portfolio securities may adversely affect the ability of the
Portfolio to dispose of such securities in a timely manner and at a price which
reflects the value of such security in the Sub-Adviser's judgment. The market
for less liquid securities tends to be more volatile than the market for more
liquid securities and market values of relatively illiquid securities may be
more susceptible to change as a result of adverse publicity and investor
perceptions than are the market values of higher-grade, more liquid securities.
A Portfolio's net asset value will change with changes in the value of its
portfolio securities. If a Portfolio invests in fixed-income securities, the
Portfolio's net asset value can be expected to change as general levels of
interest rates fluctuate. When interest rates decline, the value of a portfolio
invested in fixed-income securities can be expected to rise. Conversely, when
interest rates rise, the value of a portfolio invested in fixed-income
securities can be expected to decline. Net asset value and market value may be
volatile due to a Portfolio's investment in lower-grade and less liquid
securities. Volatility may be greater during periods of general economic
uncertainty.
A Portfolio's investments are valued pursuant to guidelines adopted and
periodically reviewed by the Board of Trustees. To the extent that there is no
established retail market for some of the securities in which a Portfolio may
invest, there may be relatively inactive trading in such securities and the
ability of the Sub-Adviser to accurately value such securities may be adversely
affected. During periods of reduced market liquidity and in the absence of
readily available market quotations for securities held in a Portfolio's
portfolio, the responsibility of the Sub-Adviser to value the Portfolio's
securities becomes more difficult and the Sub-Adviser's judgment may play a
greater role in the valuation of the Portfolio's securities due to the reduced
availability of reliable objective data. To the extent that a Portfolio invests
in illiquid securities and securities which are restricted as to resale, the
Portfolio may incur additional risks and costs.
Lower-grade securities generally involve greater credit risk than higher-grade
securities. A general economic downturn or a significant increase in interest
rates could severely disrupt the market for lower-grade securities and adversely
affect the market value of such securities. In addition, in such circumstances,
the ability of issuers of lower-grade securities to repay principal and to pay
interest, to meet projected financial goals, and to obtain additional financing
may be adversely affected. Such consequences could lead to an increased
incidence of default for such securities and adversely affect the value of the
lower-grade securities in a Portfolio's portfolio and thus a Portfolio's net
asset value. The secondary market prices of lower-grade securities are less
sensitive to changes in interest rates than are those for higher-rated
securities, but are more sensitive to adverse economic changes or individual
issuer developments. Adverse publicity and investor perceptions, whether or not
based on rational analysis, may also affect the value and liquidity of
lower-grade securities.
Yields on a Portfolio's portfolio securities can be expected to fluctuate over
time. In addition, periods of economic uncertainty and changes in interest rates
can be expected to result in increased volatility of the market prices of the
lower-grade securities in a Portfolio's portfolio and thus in the net asset
value of a Portfolio. Net asset value and market value may be volatile due to a
Portfolio's investment in lower-grade and less liquid securities. Volatility may
be greater during periods of general economic uncertainty. The Portfolios may
incur additional expenses to the extent they are required to seek recovery upon
a default in the payment of interest or a repayment of principal on their
portfolio holdings, and the Portfolios may be unable to obtain full recovery
thereof. In the event an issuer of securities held by a Portfolio experiences
difficulties in the timely payment of principal or interest and such issuer
seeks to restructure the terms of its borrowings, such Portfolio may incur
additional expenses and may determine to invest additional capital with respect
to such issuer or the project or projects to which the Portfolio's portfolio
securities relate.
The Portfolios will rely on each Sub-Adviser's judgment, analysis, and
experience in evaluating the creditworthiness of an issuer. In this evaluation,
the Sub-Adviser will take into consideration, among other things, the issuer's
financial resources, its sensitivity to economic conditions and trends, its
operating history, the quality of the issuer's management, and regulatory
matters. The Sub-Adviser also may consider, although it does not rely primarily
on, the credit ratings of S&P and Moody's in evaluating fixed-income securities.
Such ratings evaluate only the safety of principal and interest payments, not
market value risk. Additionally, because the creditworthiness of an issuer may
change more rapidly than is able to be timely reflected in changes in credit
ratings, the Sub-Adviser continuously monitors the issuers of such securities
held in the Portfolio's portfolio. A Portfolio may, if deemed appropriate by the
Sub-Adviser, retain a security whose rating has been downgraded below B by S&P
or below B by Moody's, or whose rating has been withdrawn.
INVESTMENT RESTRICTIONS
FUNDAMENTAL INVESTMENT RESTRICTIONS
The following investment restrictions are fundamental and may not be changed
with respect to any Portfolio without the approval of a majority of the
outstanding voting securities of that Portfolio. Under the 1940 Act and the
rules thereunder, a "majority of the outstanding voting securities" of a
Portfolio means the lesser of (a) 67% of the shares of that Portfolio present at
a meeting if the holders of more than 50% of the outstanding shares of that
Portfolio are present in person or by proxy and (b) more than 50% of the
outstanding shares of that Portfolio. Any investment restrictions which involve
a maximum percentage of securities or assets shall not be considered to be
violated unless an excess over the percentage occurs immediately after, and is
caused by an acquisition or encumbrance of securities or assets of, or
borrowings by or on behalf of, a Portfolio, as the case may be.
The Trust may not, on behalf of a Portfolio:
(1) With respect to 75% of its total assets, purchase the securities of any
issuer if such purchase would cause more than 5% of the value of a Portfolio's
total assets to be invested in securities of any one issuer (except securities
issued or guaranteed by the U.S. government or any agency or instrumentality
thereof), or purchase more than 10% of the outstanding voting securities of any
one issuer;
(2) Invest more than 25% of the value of its net assets in the securities
(other than U.S. government securities) of issuers in a single industry, except
that this policy shall not limit investment by the State Street Global Advisors
Money Market Portfolio in obligations of U.S. banks (excluding their foreign
branches);
(3) Borrow money (including reverse repurchase agreements), except as a
temporary measure for extraordinary or emergency purposes or, with respect to
the State Street Global Advisors Money Market Portfolio, to facilitate
redemptions (and not for leveraging or investment, except with respect to
reverse repurchase agreements and dollar roll transactions, to the extent such
investments are permitted under a Portfolio's investment objectives and
policies), provided that borrowings do not exceed an amount equal to 33 1/3% of
the current value of the Portfolio's assets taken at market value, less
liabilities other than borrowings. If at any time a Portfolio's borrowings
exceed this limitation due to a decline in net assets, such borrowings will be
reduced within three days to the extent necessary to comply with this
limitation. A Portfolio will not purchase investments once borrowed funds
(including reverse repurchase agreements) exceed 5% of its total assets;
(4) Make loans to other persons, except loans of Portfolio securities and
except to the extent that the purchase of debt obligations in accordance with
its investment objectives and policies or entry into repurchase agreements may
be deemed to be loans;
(5) Purchase or sell any commodity contract, except that each Portfolio
(other than the State Street Global Advisors Money Market Portfolio), to the
extent permitted by its investment objectives and policies, may purchase and
sell futures contracts based on debt securities, indexes of securities, and
foreign currencies and purchase and write options on securities, futures
contracts which it may purchase, securities indexes, and foreign currencies and
purchase forward contracts. (Securities denominated in gold or other precious
metals or whose value is determined by the value of gold or other precious
metals are not considered to be commodity contracts.)
(6) Underwrite securities issued by other persons except to the extent
that, in connection with the disposition of its Portfolio investments, it may be
deemed to be an underwriter under federal securities laws;
(7) Purchase or sell real estate, although (with respect to Portfolios
other than the State Street Global Advisors Money Market Portfolio) it may
purchase and sell securities which are secured by or represent interests in real
estate, mortgage-related securities, securities of companies principally engaged
in the real estate industry, and participation interests in pools of real estate
mortgage loans, and it may liquidate real estate acquired as a result of default
on a mortgage; and
(8) Issue any class of securities which is senior to a Portfolio's shares
of beneficial interest except as permitted under the 1940 Act or by order of the
SEC.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS
The following investment restrictions are non-fundamental and may be changed by
the Trustees of the Trust without shareholder approval. Although shareholder
approval is not necessary, the Trust intends to notify its shareholders before
implementing any material change in any non-fundamental investment restriction.
The Trust may not, on behalf of a Portfolio:
(1) Invest more than 15% (except 10% with respect to the Credit Suisse
International Equity Portfolio and the State Street Global Advisors Money Market
Portfolio) of the net assets of a Portfolio (taken at market value) in illiquid
securities, including repurchase agreements maturing in more than seven days;
(2) Purchase securities on margin, except (with respect to all Portfolios
other than the State Street Global Advisors Money Market Portfolio) such
short-term credits as may be necessary for the clearance of purchases and sales
of securities, and except (with respect to all Portfolios other than the State
Street Global Advisors Money Market Portfolio) that it may make margin payments
in connection with options, futures contracts, options on futures contracts, and
forward foreign currency contracts and in connection with swap agreements;
(3) Make short sales of securities unless such Portfolio (other than the
State Street Global Advisors Money Market Portfolio) owns an equal amount of
such securities or owns securities which, without payment of any further
consideration, are convertible into or exchangeable for securities of the same
issue as, and equal in amount to, the securities sold short; and
(4) Make investments for the purpose of gaining control of a company's
management.
<TABLE>
<CAPTION>
MANAGEMENT OF THE TRUST
Position Held with Principal Occupation During
Name, Address, and Age The Trust Past Five Years
- ---------------------- --------- ---------------
<S> <C> <C>
Richard W. Scott* President, Principal Executive Vice President and Chief Investment Officer
5555 San Felipe, Suite 900 Executive Officer, since February 1998 of American General Corporation;
Houston, Texas 77056 and Trustee prior thereto Vice Chairman, General Counsel and Chief
Age: 44 Investment Officer or Executive Vice President of
Western National Corporation from February 1994; prior
thereto, a partner with Vinson & Elkins L.L.P.
John A. Graf* President since December 1997 of American General
5555 San Felipe, Suite 900 Trustee Annuity Insurance Company; prior thereto Chief Marketing
Houston, Texas 77056 Officer and Vice Chairman or Executive Vice President of
Age: 38 Western National Life Insurance Company since February
1994; prior thereto Executive Vice President, Marketing of
Conseco, Inc.
Alden W. Brosseau Trustee Owner Sonoma Group Consulting to Management since March
16670 Arnold Drive 1993; prior thereto, Vice President, Investment
Sonoma, CA 95476 Administration & Planning, American General Corporation.
Age: 70
S. Tevis Grinstead Trustee Retired since 1993; prior thereto, a partner with
c/o Vinson & Elkins L.L.P. Vinson & Elkins L.L.P.
2300 First City Tower
1001 Fannin
Houston, Texas 77002-6760
Age: 59
Hugh L. Hyde Trustee Owner, HLH Consulting Inc. since November, 1994; from
952 Echo Lane, Suite 322 March 1, 1993 - September 15, 1994, President and
Houston, Texas 77024 Director of Texas Capital Bancshares, Inc. and its
Age: 55 subsidiary bank, Texas Capital Bank, N.A.; prior
thereto, a partner with KPMG Peat Marwick.
Melvin C. Payne Trustee President & Chief Executive Officer of Carriage Services
1300 Post Oak Blvd., since 1991.
Suite 1500
Houston, Texas 77045
Age: 55
Patrick F. Grady Vice President, Treasurer, Senior Vice President & Treasurer of American General
5555 San Felipe, Suite 900 Principal Financial Officer, Annuity Insurance Company since December 1997; prior
Age: 39 and Principal Accounting thereto, Vice President and Treasurer of Western National
Officer Life Insurance Company from February 1994; prior thereto
Vice President, Conseco, Inc., Carmel, Indiana.
Dwight L. Cramer Vice President Senior Vice President - Specialty Markets of American
5555 San Felipe, Suite 900 General Annuity Insurance Company since December 1997;
Houston, Texas 77056 prior thereto, from February 1996 until December 1997,
Age: 45 Senior Vice President - Law and Secretary of Western
National Life Insurance Company; prior thereto,
from November 1993 until February 1996, Vice President,
Secretary and Associate General Counsel of Western
National Life Insurance Company; prior thereto, from
January 1993 until November 1993, private law practice,
Houston, Texas.
Kurt R. Fredland Vice President, Vice President of AGA Investment Advisory Services, Inc. since
5555 San Felipe, Suite 900 Assistant Treasurer and September 1994; prior thereto Assistant Vice President -
Houston, Texas 77056 Assistant Secretary Variable Annuity Administration, Western National Life Insurance
Age: 49 Company from April 1994; prior thereto, a financial consultant.
Evelyn M. Curran Secretary Senior Attorney of American General Corporation from
5555 San Felipe, Suite 900 February 1998; prior thereto, Staff Attorney of Western
Houston, Texas 77056 National Life Insurance Company, since March 1994; prior
Age: 31 thereto, from January 1991 to March 1994, law student, South
Texas College of Law, Houston, Texas.
</TABLE>
* INTERESTED PERSON OF THE TRUST WITHIN THE MEANING OF THE 1940 ACT. EACH
TRUSTEE OF THE TRUST WHO IS NOT AN EMPLOYEE, OFFICER, OR DIRECTOR OF THE LIFE
COMPANY, THE ADVISER, OR A SUB-ADVISER RECEIVES AN ANNUAL FEE OF $7,500 AND AN
ADDITIONAL FEE OF $750 FOR EACH TRUSTEES' MEETING ATTENDED. IN ADDITION,
DISINTERESTED TRUSTEES WHO ARE MEMBERS OF ANY BOARD COMMITTEES WILL RECEIVE A
SEPARATE $750 FEE FOR ATTENDANCE OF ANY COMMITTEE MEETING THAT IS HELD ON A DAY
ON WHICH NO BOARD MEETING IS HELD. NONE OF THE TRUSTEES OR OFFICERS OF THE TRUST
OWN ANY OF THE OUTSTANDING SHARES OF THE TRUST AS OF MAY 1, 1998. WITH RESPECT
TO THE YEAR ENDED DECEMBER 31, 1997, THE TRUST PAID TRUSTEES' FEES AGGREGATING
$41,250. THE FOLLOWING TABLE SHOWS THE 1997 COMPENSATION BY TRUSTEE.
<TABLE>
<CAPTION>
COMPENSATION TABLE
(1) (2) (3) (4) (5)
Total Compensation
Aggregate Pension or Retirement Estimated Annual From Registrant
Name of Person, Compensation from Benefits Accrued Benefits Upon and Fund Complex
Position Registrant As Part of Fund Expenses Retirement Paid to Trustee
- -------- ---------- ------------------------ ---------- ---------------
<S> <C> <C> <C> <C>
Richard W. Scott None None None None
President and
Trustee
John A. Graf None None None None
Trustee
Alden W. Brosseau $ 10,500 None None $ 10,500
Trustee
Hugh L. Hyde $ 10,500 None None $ 10,500
Trustee
Melvin C. Payne $ 9,750 None None $ 9,750
Trustee
S. Tevis Grinstead $ 10,500 None None $ 10,500
Trustee
</TABLE>
SUBSTANTIAL SHAREHOLDERS
Shares of the Portfolios are issued and redeemed in connection with investments
in and payments under certain variable annuity contracts issued through a
Separate Account of the Life Company. As of May 1, 1998 the Separate Account of
the Life Company was known to the Board of Trustees and the management of the
Trust to own of record 100% of the shares of each Portfolio of the Trust.
The Declaration of Trust provides that the Trust will indemnify its Trustees and
officers against liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the Trust, except if
it is determined in the manner specified in the Declaration of Trust that they
have not acted in good faith, in the reasonable belief that their actions were
in the best interests of the Trust, or that such indemnification would relieve
any officer or Trustee of any liability to the Trust, or its shareholders by
reason of willful misfeasance, bad faith, gross negligence, or reckless
disregard of his or her duties. The Trust, at its expense, may provide liability
insurance for the benefit of its Trustees and officers.
INVESTMENT ADVISER
Under the Investment Advisory Agreement between the Trust and the Adviser (the
"Investment Advisory Agreement"), the Adviser, at its expense, provides the
Portfolios with investment advisory services and advises and assists the
officers of the Trust in taking such steps as are necessary or appropriate to
carry out the decisions of its Trustees regarding the conduct of business of the
Trust and each Portfolio. The fees to be paid under the Investment Advisory
Agreement are set forth in the Trust's prospectus. Under the Investment Advisory
Agreement, the Adviser is obligated to formulate a continuing program for the
investment of the assets of each Portfolio of the Trust in a manner consistent
with each Portfolio's investment objectives, policies, and restrictions and to
determine, from time to time, securities to be purchased, sold, retained, or
lent by the Trust and implement those decisions, subject always to the
provisions of the Trust's Declaration of Trust and By-laws, and of the 1940 Act,
and subject further to such policies and instructions as the Trustees may from
time to time establish. The Investment Advisory Agreement further provides that
the Adviser shall furnish the Trust with office space and necessary personnel,
pay ordinary office expenses, pay all executive salaries of the Trust, and
furnish, without expense to the Trust, the services of such members of its
organization as may be duly elected officers or Trustees of the Trust.
Under the Investment Advisory Agreement, the Trust is responsible for all its
other expenses including, but not limited to, the following expenses: legal,
auditing, or accounting expenses; Trustees' fees and expenses; insurance
premiums; brokers' commissions; taxes and governmental fees; expenses of issue
or redemption of shares; expenses of registering or qualifying shares for sale;
reports and notices to shareholders and fees and disbursements of custodians,
transfer agents, registrars, shareholder servicing agents, and dividend
disbursing agents; and certain expenses with respect to membership fees of
industry associations.
The Investment Advisory Agreement provides that the Adviser may retain
sub-advisers, at Adviser's own cost and expense, for the purpose of managing the
investment of the assets of one or more Portfolios. The Investment Advisory
Agreement provides that neither the Adviser nor any director, officer, or
employee of Adviser will be liable for any loss suffered by the Trust in the
absence of willful misfeasance, bad faith, gross negligence, or reckless
disregard of obligations and duties. In addition, the Agreement provides for
indemnification of the Adviser by the Trust.
The Investment Advisory Agreement may be terminated without penalty by vote of
the Trustees, as to any Portfolio by the shareholders of that Portfolio, or by
Adviser on 60 days' written notice. The Agreement also terminates without
payment of any penalty in the event of its assignment. In addition, the
Investment Advisory Agreement may be amended only by a vote of the shareholders
of the affected Portfolio(s) and provides that it will continue in effect from
year to year only so long as such continuance is approved at least annually with
respect to each Portfolio by vote of either the Trustees or the shareholders of
the Portfolio, and, in either case, by a majority of the Trustees who are not
"interested persons" of the Adviser. In each of the foregoing cases, the vote of
the shareholders is the affirmative vote of a "majority of the outstanding
voting securities" as defined in the 1940 Act.
The Adviser voluntarily agreed to waive that portion of its advisory fee which
is in excess of the amount payable by the Adviser to each Sub-Adviser pursuant
to the respective sub-advisory agreements for each Portfolio until May 1, 1998.
Thereafter, the advisory fees shown in the Prospectus under "Management of the
Trust" will be charged. In addition, the Life Company, an affiliate of the
Adviser, has undertaken to bear all operating expenses of each Portfolio,
excluding the compensation of the Adviser, that exceed .12% of each Portfolio's
average daily net assets until May 1, 1999. Information concerning the advisory
fees waived and expenses reimbursed for the period ended December 31, 1997 is
contained in the Prospectus.
For the years ended December 31, 1997, 1996 and 1995, respectively, the Adviser
was paid advisory fees as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----- ------ ----
<S> <C> <C> <C>
Credit Suisse Growth and Income Portfolio $24,528 $4,727 -
Credit Suisse International Equity Portfolio 23,693 5,824 -
EliteValue Portfolio 21,970 986 N/A
State Street Global Advisors Growth Equity
Portfolio 18,753 3,353 -
State Street Global Advisors Money Market
Portfolio 5,909 569 -
Salomon Brothers U.S. Government
Securities Portfolio 5,756 355 N/A
Van Kampen American Capital Emerging
Growth Portfolio 17,856 970 N/A
</TABLE>
For the years ended December 31, 1997, 1996 and 1995, respectively,
the Adviser waived advisory fees as follows:
<TABLE>
<CAPTION>
1997 1996 1995
----- ------- -----
<S> <C> <C> <C>
Credit Suisse Growth and Income Portfolio $12,263 $ 6,812 $3,106
Credit Suisse International Equity Portfolio 9,113 6,699 3,643
EliteValue Portfolio 13,732 6,128 N/A
State Street Global Advisors Growth Equity
Portfolio 13,030 6,520 2,490
State Street Global Advisors Money Market
Portfolio 7,387 1,878 106
Salomon Brothers U.S. Government
Securities Portfolio 6,395 7,227 N/A
Van Kampen American Capital Emerging
Growth Portfolio 8,973 5,171 N/A
</TABLE>
TRUST ADMINISTRATION
State Street Bank and Trust Company provides certain accounting, transfer
agency, and other services to the Trust.
SUB-ADVISERS
Each of the Sub-Advisers described in the Prospectus serves as Sub-Adviser to
one or more of the Portfolios of the Trust pursuant to separate written
agreements. Certain services provided by, and the fees paid to, the Sub-Advisers
are described in the Prospectus under "Management of the Trust - Sub-Advisers."
CODE OF ETHICS To mitigate the possibility that a Series will be adversely
affected by personal trading of employees, the Trust, the Adviser and the
Sub-Advisers have adopted Codes of Ethics under Rule 17j-1 of the 1940 Act.
These Codes contain policies restricting securities trading in personal accounts
of the portfolio managers and others who normally come into possession of
information on portfolio transactions. These Codes comply, in all material
respects, with the recommendations of the Investment Company Institute.
INVESTMENT DECISIONS
Investment decisions for the Trust and for the other investment advisory clients
of the Sub-Advisers are made with a view to achieving their respective
investment objectives and after consideration of such factors as their current
holdings, availability of cash for investment, and the size of their investments
generally. Frequently, a particular security may be bought or sold for only one
client or in different amounts and at different times for more than one, but
less than all clients. Likewise, a particular security may be bought for one or
more clients when one or more other clients are selling the security. In
addition, purchases or sales of the same security may be made for two or more
clients of a Sub-Adviser on the same day. In such event, such transactions will
be allocated among the clients in a manner believed by the Sub-Adviser to be
equitable to each. In some cases, this procedure could have an adverse effect on
the price or amount of the securities purchased or sold by the Trust. Purchase
and sale orders for the Trust may be combined with those of other clients of a
Sub-Adviser in the interest of achieving the most favorable net results for the
Trust.
BROKERAGE AND RESEARCH SERVICES
Transactions on U.S. stock exchanges and other agency transactions involve the
payment by the Trust of negotiated brokerage commissions. Such commissions vary
among different brokers. Also, a particular broker may charge different
commissions according to such factors as the difficulty and size of the
transaction. Transactions in foreign securities often involve the payment of
fixed brokerage commissions, which are generally higher than those in the United
States. There is generally no stated commission in the case of securities traded
in the over-the-counter markets, but the price paid by the Trust usually
includes an undisclosed dealer commission or mark-up. In underwritten offerings,
the price paid by the Trust includes a disclosed, fixed commission or discount
retained by the underwriter or dealer. It is currently intended that the
Sub-Advisers will place all orders for the purchase and sale of portfolio
securities for the Trust and buy and sell securities for the Trust through a
substantial number of brokers and dealers. In so doing, the Sub-Advisers will
use their best efforts to obtain for the Trust the best price and execution
available. In seeking the best price and execution, the Sub-Advisers, having in
mind the Trust's best interests, will consider all factors they deem relevant,
including, by way of illustration, price; the size of the transaction; the
nature of the market for the security; the amount of the commission; the timing
of the transaction taking into account market prices and trends; the reputation,
experience, and financial stability of the broker-dealer involved; and the
quality of service rendered by the broker-dealer in other transactions.
It has for many years been a common practice in the investment advisory business
for advisers of investment companies and other institutional investors to
receive research, statistical, and quotation services from broker-dealers who
execute portfolio transactions for the clients of such advisers. Consistent with
this practice, the Sub-Advisers may receive research, statistical, and quotation
services from any broker-dealers with whom they place the Trust's portfolio
transactions. These services, which in some cases may also be purchased for
cash, include such matters as general economic and security market reviews,
industry and company reviews, evaluations of securities, and recommendations as
to the purchase and sale of securities. Some of these services may be of value
to the Sub-Advisers and/or their affiliates in advising various other clients
(including the Trust), although not all of these services are necessarily useful
and of value in managing the Trust. The management fees paid by the Trust are
not reduced because the Sub-Advisers and/or their affiliates may receive such
services.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, a
Sub-Adviser may cause a Portfolio to pay a broker-dealer who provides brokerage
and research services to the Sub-Adviser an amount of disclosed commission for
effecting a securities transaction for the Portfolio in excess of the commission
which another broker-dealer would have charged for effecting that transaction
provided that the Sub-Adviser determines in good faith that such commission was
reasonable in relation to the value of the brokerage and research services
provided by such broker-dealer, viewed in terms of that particular transaction
or in terms of all of the accounts over which investment discretion is so
exercised. A Sub-Adviser's authority to cause a Portfolio to pay any such
greater commissions is also subject to such policies as the Adviser or the
Trustees may adopt from time to time.
During the Trust's fiscal years ended December 31, 1997 and December 31, 1996,
the Portfolios paid the following amounts in brokerage commissions:
<TABLE>
<CAPTION>
1997 1996
------- ------
<S> <C> <C>
Credit Suisse Growth and Income Portfolio,
formerly BEA Growth and Income Portfolio $ 7,681 $13,588
Credit Suisse International Equity Portfolio 14,086 14,302
EliteValue Portfolio, formerly EliteValue Asset
Allocation Portfolio 6,958 2,448
State Street Global Advisors Growth Equity
Portfolio, formerly Global Advisors Growth
Equity Portfolio 10,851 4,082
State Street Global Advisors Money Market
Portfolio, formerly Global Advisors Money
Market Portfolio -- --
Salomon Brothers U.S. Government
Securities Portfolio -- --
Van Kampen American Capital Emerging
Growth Portfolio 5,131 3,423
During the Trust's fiscal year ended December 31, 1997, the following aggregate
dollar amounts of brokerage commissions were paid to affiliated brokers by the
respective Portfolios along with the percentage that such amounts represent of
each Portfolio's aggregate annual brokerage commissions paid: Credit Suisse
International Equity Portfolio $169 - 1.21% to Salomon Inc and $126 or .89% to
CS First Boston; EliteValue Portfolio $186 or 2.67% to Salomon Inc and $186 or
2.67% to CS First Boston; State Street Global Advisors Growth Equity $607 or
5.59% to Salomon Inc and $465 or 4.29% to CS First Boston and Van Kampen
American Capital Emerging Growth Portfolio $483 or 9.41% to Salomon Inc and
$2,117 or 41.26% to CS First Boston.
</TABLE>
DETERMINATION OF NET ASSET VALUE
The net asset value per share of each Portfolio is determined daily as of 4:00
p.m., New York time, on each day the NYSE is open for trading. The NYSE is
normally closed on the following national holidays: New Year's Day, Martin
Luther King's Birthday, President's Day, Good Friday, Memorial Day, Independence
Day, Labor Day, Thanksgiving, and Christmas.
The value of a foreign security is determined in its national currency as of the
close of trading on the foreign exchange on which it is traded or as of 4:00
p.m., New York time, if that is earlier, and that value is then converted into
its U.S. dollar equivalent at the foreign exchange rate in effect at noon, New
York time, on the day the value of the foreign security is determined.
The valuation of the State Street Global Advisors Money Market Portfolio's
portfolio securities is based upon their amortized cost, which does not take
into account unrealized securities gains or losses. This method involves
initially valuing an instrument at its cost and thereafter assuming a constant
amortization to maturity of any discount or premium, regardless of the effect of
fluctuating interest rates on the market value of the instrument. By using
amortized cost valuation, the Trust seeks to maintain a constant net asset value
of $1 per share for the State Street Global Advisors Money Market Portfolio,
despite minor shifts in the market value of its portfolio securities. While this
method provides certainty in valuation, it may result in periods during which
value, as determined by amortized cost, is higher or lower than the price the
State Street Global Advisors Money Market Portfolio would receive if it sold the
instrument. During periods of declining interest rates, the quoted yield on
shares of the State Street Global Advisors Money Market Portfolio may tend to be
higher than a like computation made by a fund with identical investments
utilizing a method of valuation based on market prices and estimates of market
prices for all of its portfolio instruments. Thus, if the use of amortized cost
by the Portfolio resulted in a lower aggregate portfolio value on a particular
day, a prospective investor in the State Street Global Advisors Money Market
Portfolio would be able to obtain a somewhat higher yield if he or she purchased
shares of the Global Advisors Money Market Portfolio on that day, than would
result from investment in a fund utilizing solely market values, and existing
investors in the State Street Global Advisors Money Market Portfolio would
receive less investment income. The converse would apply on a day when the use
of amortized cost by the Portfolio resulted in a higher aggregate portfolio
value. However, as a result of certain procedures adopted by the Trust, the
Trust believes any difference will normally be minimal.
The net asset value of the shares of each of the Portfolios, other than the
State Street Global Advisors Money Market Portfolio, is determined by dividing
the total assets of the Portfolio, less all liabilities, by the total number of
shares outstanding. Securities traded on a national securities exchange or
quoted on the NASDAQ National Market System are valued at their last-reported
sale price on the principal exchange or reported by NASDAQ or, if there is no
reported sale, and in the case of over-the-counter securities not included in
the NASDAQ National Market System, at a bid price estimated by a broker or
dealer. Debt securities, including zero-coupon securities and certain foreign
securities, will be valued by a pricing service. Other foreign securities will
be valued by the Trust's custodian. Securities for which current market
quotations are not readily available and all other assets are valued at fair
value as determined in good faith by the Trustees, although the actual
calculations may be made by persons acting pursuant to the direction of the
Trustees.
If any securities held by a Portfolio are restricted as to resale, their fair
value is generally determined as the amount which the Trust could reasonably
expect to realize from an orderly disposition of such securities over a
reasonable period of time. The valuation procedures applied in any specific
instance are likely to vary from case to case. However, consideration is
generally given to the financial position of the issuer and other fundamental
analytical data relating to the investment and to the nature of the restrictions
on disposition of the securities (including any registration expenses that might
be borne by the Trust in connection with such disposition). In addition,
specific factors are also generally considered, such as the cost of the
investment, the market value of any unrestricted securities of the same class
(both at the time of purchase and at the time of valuation), the size of the
holding, the prices of any recent transactions or offers with respect to such
securities, and any available analysts' reports regarding the issuer.
Generally, trading in certain securities (such as foreign securities) is
substantially completed each day at various times prior to the close of the
NYSE. The values of these securities used in determining the net asset value of
the Trust's shares are computed as of such times. Also, because of the amount of
time required to collect and process trading information as to large numbers of
securities issues, the values of certain securities (such as convertible bonds
and U.S. government securities) are determined based on market quotations
collected earlier in the day at the latest practicable time prior to the close
of the NYSE. Occasionally, events affecting the value of such securities may
occur between such times and the close of the NYSE which will not be reflected
in the computation of the Trust's net asset value. If events materially
affecting the value of such securities occur during such period, then these
securities will be valued at their fair value, in the manner described above.
The proceeds received by each Portfolio for each issue or sale of its shares,
and all income, earnings, profits, and proceeds thereof, subject only to the
rights of creditors, will be specifically allocated to such Portfolio, and
constitute the underlying assets of that Portfolio. The underlying assets of
each Portfolio will be segregated on the Trust's books of account and will be
charged with the liabilities in respect of such Portfolio and with a share of
the general liabilities of the Trust. Expenses with respect to any two or more
Portfolios may be allocated in proportion to the net asset values of the
respective Portfolios except where allocations of direct expenses can otherwise
be fairly made.
TAXES
Each Portfolio of the Trust intends to qualify each year and elect to be taxed
as a regulated investment company under Subchapter M of the Internal Revenue
Code of 1986, as amended (the "Code"). As a regulated investment company
qualifying to have its tax liability determined under Subchapter M, a Portfolio
will not be subject to federal income tax on any of its net investment income or
net realized capital gains that are distributed to the Separate Account of the
Life Company. As a Massachusetts business trust, a Portfolio, under present law,
will not be subject to any excise or income taxes in Massachusetts.
In order to qualify as a "regulated investment company," a Portfolio must, among
other things: (a) derive at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, gains from the sale or
other disposition of stock, securities, or foreign currencies, and other income
(including gains from options, futures, or forward contracts) derived with
respect to its business of investing in such stock, securities, or currencies;
and (b) diversify its holdings so that, at the close of each quarter of its
taxable year, (i) at least 50% of the value of its total assets consists of
cash, cash items, U.S. government securities, and other securities limited
generally with respect to any one issuer to not more than 5% of the total assets
of the Portfolio and not more than 10% of the outstanding voting securities of
such issuer and (ii) not more than 25% of the value of its assets is invested in
the securities of any issuer (other than U.S. government securities). Moreover,
in order to receive the favorable tax treatment accorded regulated investment
companies and their shareholders, a Portfolio must, in general, distribute at
least 90% of its interest, dividends, net short-term capital gain, and certain
other income each year.
With respect to investment income and gains received by a Portfolio from sources
outside the United States, such income and gains may be subject to foreign taxes
which are withheld at the source. The effective rate of foreign taxes in which a
Portfolio will be subject depends on the specific countries in which its assets
will be invested and the extent of the assets invested in each such country and,
therefore, cannot be determined in advance.
A Portfolio's ability to use options, futures, and forward contracts and other
hedging techniques, and to engage in certain other transactions, may be limited
by tax considerations. A Portfolio's transactions in
foreign-currency-denominated debt instruments and its hedging activities will
likely produce a difference between its book income and its taxable income. This
difference may cause a portion of the Portfolio's distributions of book income
to constitute returns of capital for tax purposes or require the Portfolio to
make distributions exceeding book income in order to permit the Trust to
continue to qualify and be taxed under Subchapter M of the Code, as a regulated
investment company.
Under federal income tax law, a portion of the difference between the purchase
price of zero-coupon securities in which a Portfolio has invested and their face
value ("original issue discount") is considered to be income to the Portfolio
each year, even though the Portfolio will not receive cash interest payments
from these securities. This original issue discount (imputed income) will
comprise a part of the net investment income of the Portfolio which must be
distributed to shareholders in order to maintain the qualification of the
Portfolio as a regulated investment company and to avoid federal income tax at
the level of the Portfolio.
It is the policy of each of the Portfolios to meet the requirements of the Code
to qualify as a regulated investment company that is taxed pursuant to
Subchapter M of the Code.
This discussion of the federal income tax and state tax treatment of the Trust
and its shareholders is based on the law as of the date of this SAI. It does not
describe in any respect the tax treatment of any insurance or other product
pursuant to which investments in the Trust may be made. For further information
concerning federal income tax consequences for the holders of the VA Contracts
of the Life Company, investors should consult the Prospectus used in connection
with the issuance of their VA Contracts.
DIVIDENDS AND DISTRIBUTIONS
STATE STREET GLOBAL ADVISORS MONEY MARKET PORTFOLIO. The net investment
income of the State Street Global Advisors Money Market Portfolio is determined
as of the close of trading on the NYSE (generally 4 p.m., New York time) on each
day on which the NYSE is open for business. All of the net investment income so
determined normally will be declared daily as a dividend to shareholders of
record as of the close of trading on the NYSE after the purchase and redemption
of shares. Unless the business day before a weekend or holiday is the last day
of an accounting period, the dividend declared on that day will include an
amount in respect of the Portfolio's income for the subsequent non-business day
or days. No daily dividend will include any amount of net income in respect of a
subsequent semi-annual accounting period. Dividends commence on the next
business day after the date of purchase. Dividends declared during any month
will be invested as of the close of business on the last calendar day of that
month (or the next business day after the last calendar day of the month if the
last calendar day of the month is a non-business day) in additional shares of
the Portfolio at the net asset value per share, normally $1, determined as of
the close of business on that day, unless payment of the dividend in cash has
been requested.
Net income of the State Street Global Advisors Money Market Portfolio consists
of all interest income accrued on portfolio assets less all expenses of the
Portfolio and amortized market premium. Amortized market discount is included in
interest income. The Portfolio does not anticipate that it will normally realize
any long-term capital gains with respect to its portfolio securities.
Normally the State Street Global Advisors Money Market Portfolio will have a
positive net income at the time of each determination thereof. Net income may be
negative if an unexpected liability must be accrued or a loss realized. If the
net income of the Portfolio determined at any time is a negative amount, the net
asset value per share will be reduced below $1 unless one or more of the
following steps, for which the Trustees have authority, are taken: (a) reducing
the number of shares in each shareholder's account; (b) offsetting each
shareholder's pro rata portion of negative net income against the shareholder's
accrued dividend account or against future dividends; or (c) combining these
methods in order to seek to maintain the net asset value per share at $1. The
Trust may endeavor to restore the Portfolio's net asset value per share to $1 by
not declaring dividends from net income on subsequent days until restoration,
with the result that the net asset value per share will increase to the extent
of positive net income which is not declared as a dividend.
Should the State Street Global Advisors Money Market Portfolio incur or
anticipate, with respect to its portfolio, any unusual or unexpected significant
expense or loss which would affect disproportionately the Portfolio's income for
a particular period, the Trustees would at that time consider whether to adhere
to the dividend policy described above or to revise it in light of the
then-prevailing circumstances in order to ameliorate, to the extent possible,
the disproportionate effect of such expense or loss on then-existing
shareholders. Such expenses or losses may, nevertheless, result in a shareholder
receiving no dividends for the period during which the shares are held, and
receiving, upon redemption, a price per share lower than that which was paid.
OTHER PORTFOLIOS. Each of the Portfolios, other than the State Street
Global Advisors Money Market Portfolio, will declare and distribute dividends
from net investment income, if any, and will distribute its net realized capital
gains, if any, at least annually. Both dividends and capital gain distributions
will be made in shares of such Portfolios unless an election is made on behalf
of a separate account to receive dividends and capital gain distributions in
cash.
PERFORMANCE INFORMATION
State Street Global Advisors Money Market Portfolio: The Portfolio's yield
is computed by determining the percentage net change, excluding capital changes,
in the value of an investment in one share of the Portfolio over the base
period, and multiplying the net change by 365/7 (or approximately 52 weeks). The
Portfolio's effective yield represents a compounding of the yield by adding one
to the number representing the percentage change in value of the investment
during the base period, raising that sum to a power equal to 365/7, and
subtracting one from the result.
OTHER PORTFOLIOS:
(a) A Portfolio's yield is presented for a specified 30-day period (the
"base period"). Yield is based on the amount determined by: (i) calculating the
aggregate of dividends and interest earned by the Portfolio during the base
period, less expenses accrued for that period and (ii) dividing that amount by
the product of (A) the average daily number of shares of the Portfolio
outstanding during the base period and entitled to receive dividends, and (B)
the net asset value per share of the Portfolio on the last day of the base
period. The result is annualized on a compounding basis to determine the
Portfolio's yield. For this calculation, interest earned on debt obligations
held by a Portfolio is generally calculated using the yield to maturity (or
first expected call date) of such obligations based on their market values (or,
in the case of receivables-backed securities such as Ginnie Maes, based on
cost). Dividends on equity securities are accrued daily at their stated dividend
rates.
As required by regulations of the SEC, the annualized total return of a
Portfolio for a period is computed by assuming a hypothetical initial payment of
$1,000. It is then assumed that all of the dividends and distributions by the
Portfolio over the period are reinvested. It is then assumed that at the end of
the period, the entire amount is redeemed. The annualized total return is then
calculated by determining the annual rate required for the initial payment to
grow to the amount which would have been received upon redemption.
Investment operations for the Portfolios depicted in the chart below commenced
on October 10, 1995, for the State Street Global Advisors Money Market
Portfolio; on October 20, 1995, for the Credit Suisse Growth and Income, Credit
Suisse International Equity, and State Street Global Advisors Growth Equity
Portfolios; on January 2, 1996 EliteValue, and Van Kampen American Capital
Emerging Growth Portfolios; and on February 6, 1996, for the Salomon Brothers
U.S. Government Securities Portfolio. The performance figures shown for the
Portfolios in the chart below reflect the actual fees and expenses paid by the
Portfolios.
AVERAGE TOTAL RETURN FOR THE PERIODS INDICATED
<TABLE>
<CAPTION>
12 Months Ended Inception to
Portfolio 12/31/97 12/31/97
- --------- -------- --------
<S> <C> <C>
Credit Suisse Growth and Income Portfolio,
formerly BEA Growth and Income Portfolio 22.33% 19.62%
Credit Suisse International Equity Portfolio 4.30% 11.18%
EliteValue Portfolio, formerly EliteValue
Asset Allocation Portfolio 21.08% 23.86%
State Street Global Advisors Growth Equity
Portfolio, formerly Global Advisors Equity
Portfolio 31.67% 25.70%
State Street Global Advisors Money Market
Portfolio, formerly Global Advisors Money
Market Portfolio 5.50% 5.33%
Salomon Brothers U.S. Government
Securities Portfolio 8.89% 6.42%
Van Kampen American Capital Emerging
Growth Portfolio 20.45% 19.75%
</TABLE>
From time to time, the Adviser may reduce its compensation or assume expenses
with respect to the operations of a Portfolio in order to reduce the Portfolio's
expenses. Any such waiver or assumption would increase a Portfolio's yield and
total return during the period of the waiver or assumption.
SHAREHOLDER COMMUNICATIONS
Owners of Variable Annuity contracts issued by the Life Company for which shares
of one or more Portfolios are the investment vehicles are entitled to receive
from the Life Company unaudited semi-annual financial statements and audited
year-end financial statements certified by the Trust's independent public
accountants. Each report will show the investments owned by the Portfolio and
the market value thereof and will provide other information about the Portfolio
and its operations.
ORGANIZATION AND CAPITALIZATION
The Trust is an open-end investment company established under the laws of The
Commonwealth of Massachusetts by a Declaration of Trust dated December 12, 1994,
as amended April 19, 1995 and May 1, 1998.
Shares entitle their holders to one vote per share, with fractional shares
voting proportionately; however, a separate vote will be taken by each Portfolio
on matters affecting an individual Portfolio. For example, a change in a
fundamental investment policy for the Credit Suisse Growth and Income Portfolio
would be voted upon only by shareholders of that Portfolio. Additionally,
approval of the Investment Advisory Agreement is a matter to be determined
separately by each Portfolio. Approval by the shareholders of one Portfolio is
effective as to that Portfolio. Shares have noncumulative voting rights.
Although the Trust is not required to hold annual meetings of its shareholders,
shareholders have the right to call a meeting to elect or remove Trustees or to
take other actions as provided in the Declaration of Trust. Shares have no
preemptive or subscription rights, and are transferable. Shares are entitled to
dividends as declared by the Trustees, and if a Portfolio were liquidated, the
shares of that Portfolio would receive the net assets of that Portfolio. The
Trust may suspend the sale of shares at any time and may refuse any order to
purchase shares.
Additional Portfolios may be created from time to time with different investment
objectives or for use as funding vehicles for different variable life insurance
policies or variable annuity contracts. Any additional Portfolios may be managed
by investment advisers or sub-advisers other than the current Adviser and
Sub-Advisers. In addition, the Trustees have the right, subject to any necessary
regulatory approvals, to create more than one class of shares in a Portfolio,
with the classes being subject to different charges and expenses and having such
other different rights as the Trustees may prescribe and to terminate any
Portfolio of the Trust.
PORTFOLIO TURNOVER
The portfolio turnover rate of a Portfolio is defined by the SEC as the ratio of
the lesser of annual sales or purchases to the monthly average value of the
portfolio, excluding from both the numerator and the denominator securities with
maturities at the time of acquisition of one year or less. Under that
definition, the State Street Global Advisors Money Market Portfolio would not
calculate portfolio turnover. Portfolio turnover generally involves some expense
to a Portfolio, including brokerage commissions or dealer mark- ups and other
transaction costs on the sale of securities and reinvestment in other
securities. The portfolio turnover rate of each of the Portfolios for the period
ended December 31, 1995, for the applicable Portfolios and December 31, 1996,
for all Portfolios is set forth under "Financial Highlights" in the Prospectus.
CUSTODIAN
State Street Bank and Trust Company is the custodian of the Trust's assets. The
custodian's responsibilities include safeguarding and controlling the Trust's
cash and securities, handling the receipt and delivery of securities, and
collecting interest and dividends on the Trust's investments. The Trust may
employ foreign sub-custodians that are approved by the Board of Trustees to hold
foreign assets.
LEGAL COUNSEL
Legal matters in connection with the offering are being passed upon by Blazzard,
Grodd & Hasenauer, P.C., Westport, Connecticut.
INDEPENDENT ACCOUNTANTS
The Trust has selected Coopers & Lybrand L.L.P. as the independent accountants
to audit the annual financial statements of the Trust.
SHAREHOLDER LIABILITY
Under Massachusetts law, shareholders could, under certain circumstances, be
held personally liable for the obligations of the Trust. However, the
Declaration of Trust disclaims shareholder liability for acts or obligations of
the Trust and requires that notice of such disclaimer be given in each
agreement, obligation, or instrument entered into or executed by the Trust or
the Trustees. The Declaration of Trust provides for indemnification out of a
Portfolio's property for all loss and expense of any shareholder held personally
liable for the obligations of a Portfolio. Thus the risk of a shareholder's
incurring financial loss on account of shareholder liability is limited to
circumstances in which the Portfolio would be unable to meet its obligations.
DESCRIPTION OF NRSRO RATINGS
DESCRIPTION OF MOODY'S CORPORATE RATINGS
Aaa - Bonds which are rated "Aaa" are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt-edge." Interest payments are protected by a large or an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa - Bonds which are rated "Aa" are judged to be of high quality by all
standards. Together with the "Aaa" group, they comprise what are generally known
as high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in "Aaa"
securities.
A - Bonds which are rated "A" possess many favorable investment attributes
and are to be considered as upper medium-grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
Baa - Bonds which are rated "Baa" are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present, but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and, in fact, have speculative characteristics as well.
Ba - Bonds which are rated "Ba" are judged to have speculative elements;
their future cannot be considered as well assured. Often the protection of
interest and principal payments may be very moderate and thereby not
well-safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B - Bonds which are rated "B" generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa - Bonds which are rated "Caa" are of poor standing. Such issues may be
in default or there may be present elements of danger with respect to principal
or interest.
Ca - Bonds which are rated "Ca" represent obligations which are speculative
in a high degree. Such issues are often in default or have other marked
shortcomings.
C - Bonds which are rated "C" are the lowest-rated class of bonds. Issues
so rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
DESCRIPTION OF S&P'S CORPORATE RATINGS
AAA - Bonds rated "AAA" have the highest rating assigned by Standard &
Poor's to a debt obligation. 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 bonds 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- Bonds rated "BB," "B," "CCC," "CC," and "C" are
regarded, on balance, as predominantly speculative with respect to the issuer's
capacity to pay interest and repay principal in accordance with the terms of the
obligation. "BB" indicates the least degree of speculation and "C" the highest
degree of speculation. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions. A rating of "C" is typically applied to
debt subordinated to senior debt which is assigned an actual or implied "CCC"
rating. It may also be used to cover a situation where a bankruptcy petition has
been filed, but debt service payments are continued.
DESCRIPTION OF DUFF CORPORATE RATINGS
AAA - Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA - Risk is modest but may vary slightly from time to time because of
economic conditions.
A - Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
BBB - Investment-grade. Considerable variability in risk during economic
cycles.
BB - Below investment-grade but deemed likely to meet obligations when due.
Present or prospective financial protection factors fluctuate according to
industry conditions or company fortunes. Overall quality may move up or down
frequently within this category.
B - Below investment-grade and possessing risk that obligations will not be
met when due. Financial protection factors will fluctuate widely according to
economic cycles, industry conditions, and/or company fortunes. Potential exists
for frequent changes in quality rating within this category or into a higher- or
lower-quality rating grade.
Substantial Risk - Well below investment-grade securities. May be in
default or have considerable uncertainty as to timely payment of interest,
preferred dividends, and/or principal. Protection factors are narrow and risk
can be substantial with unfavorable economic/industry conditions, and/or with
favorable company developments.
DESCRIPTION OF FITCH CORPORATE RATINGS
AAA - Bonds considered to be investment-grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events.
AA- Bonds considered to be investment-grade and of very high credit
quality. The obligor's ability to pay interest and repay principal is very
strong, although not quite as strong as bonds rated "AAA." Because bonds rated
in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable
future developments, short-term debt of these issues is generally rated "[-]+."
A - Bonds considered to be investment-grade and of high credit quality. The
obligor's ability to pay interest and to repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment-grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is considered
to be adequate. Adverse changes in economic conditions and circumstances,
however, are more likely to have an adverse effect on these bonds, and,
therefore, impair timely payment. The likelihood that the ratings of these bonds
will fall below investment-grade is higher than for bonds with higher ratings.
BB - Bonds considered speculative and of low investment grade. The
obligor's ability to pay interest and repay principal is not strong and is
considered likely to be affected over time by adverse economic changes.
B - Bonds considered highly speculative. Bonds in this class are lightly
protected as to the obligor's ability to pay interest over the life of the issue
and repay principal when due.
CCC - Bonds which may have certain identifiable characteristics which, if
not remedied, could lead to the possibility of default in either principal or
interest payments.
CC - Bonds which are minimally protected. Default in payment of interest
and/or principal seems probable.
C - Bonds which are in imminent default in payment of interest or
principal.
DESCRIPTION OF THOMSON BANKWATCH, INC. CORPORATE RATINGS
AAA - Long-term, fixed-income securities that are rated "AAA" indicate that
the ability to repay principal and interest on a timely basis is very high.
AA - Long-term, fixed-income securities that are rated "AA" indicate a
superior ability to repay principal and interest on a timely basis with limited
incremental risk vs. issues rated in the highest category.
TBW may apply plus ("+") and minus ("-") modifiers in the "AAA" and "AA"
categories to indicate where within the respective category the issued security
is placed.
DESCRIPTION OF IBCA LIMITED AND IBCA INC. CORPORATE RATINGS
AAA - Obligations which are rated "AAA" are considered to be of the lowest
expectation of investment risk. Capacity for timely repayment of principal and
interest is substantial such that adverse changes in business, economic, or
financial conditions are unlikely to increase investment risk significantly.
AA - Obligations which are rated "AA" are considered to be of a very low
expectation of investment risk. Capacity for timely repayment of principal and
interest is substantial. Adverse changes in business, economic, or financial
conditions may increase investment risk, albeit not very significantly.
DESCRIPTION OF S&P'S COMMERCIAL PAPER RATINGS
Commercial paper rated "A-1" by S&P indicates that the degree of safety
regarding timely payments is either over-whelming or very strong. Those issues
determined to possess overwhelming safety characteristics are denoted "A-1+."
Capacity for timely payment on commercial paper rated "A-2" is strong, but the
relative degree of safety is not as high as for issues designated "A-1." An
"A-3" designation indicates an adequate capacity for timely payment. Issues with
this designation, however, are more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations. "B" issues
are regarded as having only speculative capacity for timely payment. "C" issues
have a doubtful capacity for payment. "D" issues are in payment default. The "D"
rating category is used when interest payments or principal payments are not
made on the due date, even if the applicable grace period has not expired,
unless Standard & Poor's believes that such payments will be made during such
grace period.
DESCRIPTION OF MOODY'S COMMERCIAL PAPER RATINGS
The rating "Prime-1" is the highest commercial paper rating assigned by
Moody's. Issuers rated "Prime-1" (or related supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations. Issuers rated "Prime-2" (or related supporting institutions) are
considered to have a strong capacity for repayment of short-term promissory
obligations. This will normally be evidenced by many of the characteristics of
issuers rated "Prime-1" but to a lesser degree. Earnings trend and coverage
ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternative liquidity is maintained. "P-3" issuers have an
acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained. Not Prime
issuers do not fall within any of the Prime rating categories.
DESCRIPTION OF DUFF COMMERCIAL PAPER RATINGS
The rating "Duff-1" is the highest commercial paper rating assigned by Duff
& Phelps. Paper rated "Duff-1" is regarded as having very high certainty of
timely payment with excellent liquidity factors which are supported by ample
asset protection. Risk factors are minor. Paper rated "Duff-2" is regarded as
having good certainty of timely payment, good access to capital markets, and
sound liquidity factors and company fundamentals. Risk factors are small.
DESCRIPTION OF FITCH COMMERCIAL PAPER RATINGS
The rating "Fitch-1" (Highest Grade) is the highest commercial paper rating
assigned by Fitch. Paper rated "Fitch-1" is regarded as having the strongest
degree of assurance for timely payment. The rating "Fitch-2" (Very Good Grade)
is the second highest commercial paper rating assigned by Fitch which reflects
an assurance of timely payment only slightly less in degree than the strongest
issues.
DESCRIPTION OF IBCA LIMITED AND IBCA INC. COMMERCIAL PAPER RATINGS
A1 - Short-term obligations rated "A1" are supported by a very strong
capacity for timely repayment. A plus ("+") sign is added to those issues
determined to possess the highest capacity for timely payment.
A2 - Short-term obligations rated "A2" are supported by a strong capacity
for timely repayment, although such capacity may be susceptible to adverse
changes in business, economic, or financial conditions.
DESCRIPTION OF THOMSON BANKWATCH, INC. COMMERCIAL PAPER RATINGS
TBW-1 - Short-term obligations rated "TBW-1" indicate a very high degree of
likelihood that principal and interest will be paid on a timely basis.
TBW-2 - Short-term obligations rated "TBW-2" indicate 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."
FINANCIAL STATEMENTS
The Trust's financial statements and notes thereto for the year ended December
31, 1997, are incorporated by reference to the WNL Series Trust 1997 Annual
Report filed on March 6, 1998.
