NATIONS FUND TRUST
NATIONS FUND, INC.
NATIONS FUND PORTFOLIOS, INC.
PRIMARY A SHARES
SUPPLEMENT DATED AUGUST 15, 1996
TO PROSPECTUSES DATED JULY 31, 1996
The Prospectuses for the Primary A Shares of each Fund of Nations Fund
Trust, Nations Fund, Inc. and Nations Fund Portfolios, Inc. are hereby amended
and supplemented as follows:
By substituting the following for the last sentence in the section
entitled "ABOUT THE FUNDS-PROSPECTUS SUMMARY":
MINIMUM PURCHASE: $500,000 minimum initial investment per record
holder. See "How To Buy Shares."
2. By substituting the following for the first paragraph in the section
entitled "ABOUT YOUR INVESTMENT-HOW TO BUY SHARES":
There is a minimum initial investment of $500,000 for each record
holder; there is no minimum subsequent investment.
Primary A Shares may be sold to NationsBank and its affiliates
acting on behalf of bona fide trust customers. Primary A Shares
also may be sold to employee benefit plans, charitable
foundations, endowments and to other funds in the Nations Fund
Family.
3. By deleting the fourth paragraph in the section entitled "ABOUT YOUR
INVESTMENT-HOW TO BUY SHARES."
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NATIONS FUND PORTFOLIOS, INC.
Statement of Additional Information
NATIONS EMERGING MARKETS FUND
NATIONS PACIFIC GROWTH FUND
NATIONS GLOBAL GOVERNMENT INCOME FUND
Investor Shares and Primary Shares
July 31, 1996
This Statement of Additional Information ("SAI") provides supplementary
information pertaining to the classes of shares representing interests in the
above listed three investment portfolios of Nations Fund Portfolios, Inc.
(individually, a "Fund" and collectively, the "Funds"). This SAI is not a
prospectus, and should be read only in conjunction with the current prospectuses
for the aforementioned Funds related to the class or series of shares in which
one is interested, dated July 31, 1996 (each a "Prospectus"). All terms used in
this SAI that are defined in the Prospectuses will have the same meanings
assigned in the Prospectuses. Copies of these Prospectuses may be obtained by
writing Nations Fund c/o Stephens Inc., One NationsBank Plaza, 33rd Floor,
Charlotte, North Carolina 28255, or by calling Nations Fund at 1-800-321-7854.
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TABLE OF CONTENTS
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INTRODUCTION............................................................................ 1
FUND TRANSACTIONS AND BROKERAGE......................................................... 1
General Brokerage Policy........................................................... 1
Section 28(e) Standards............................................................ 3
ADDITIONAL INFORMATION ON FUND INVESTMENTS.............................................. 4
General............................................................................ 4
When-Issued Securities............................................................. 5
Delayed Delivery Transactions...................................................... 5
Foreign Currency Transactions ..................................................... 6
Futures, Options and Other Derivative
Instruments ................................................................. 7
Risk Factors Associated with Futures and
Options Transactions......................................................... 14
Interest Rate Transactions ........................................................ 17
Asset-Backed Securities ........................................................... 18
Special Situations................................................................. 21
Equity Swap Contracts.............................................................. 21
Reverse Repurchase Agreements ..................................................... 22
Securities Lending ................................................................ 23
Short Sales........................................................................ 23
Guaranteed Investment Contracts.................................................... 23
Illiquid Securities................................................................ 24
Commercial Instruments............................................................. 24
Municipal Securities............................................................... 25
Real Estate Investment Trusts ..................................................... 26
Additional Investment Limitations ................................................. 27
NET ASSET VALUE......................................................................... 29
Purchases and Redemptions.......................................................... 29
Net Asset Value Determination...................................................... 29
Exchanges.......................................................................... 30
DESCRIPTION OF SHARES................................................................... 30
Dividends and Distributions........................................................ 30
Emerging Markets Fund and Pacific
Growth Fund.................................................................. 31
Global Government Income Fund...................................................... 31
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ADDITIONAL INFORMATION CONCERNING TAXES................................................. 32
Qualification as a Regulated Investment
Company........................................................................ 32
Excise Tax on Regulated Investment Companies....................................... 34
Sale or Redemption of Shares....................................................... 34
Foreign Shareholders............................................................... 35
Effect of Future Legislation; Local Tax
Considerations ............................................................. 36
DIRECTORS AND OFFICERS.................................................................. 37
Nations Funds Retirement Plan.................................................. 40
Nations Funds Deferred Compensation Plan........................................... 41
Compensation Table................................................................. 41
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY, SHAREHOLDER SERVICING, SHAREHOLDER
ADMINISTRATION AND DISTRIBUTION AGREEMENTS.............................................. 42
The Company and Its Common Stock................................................... 42
Investment Adviser................................................................. 43
Investment Styles.................................................................. 46
Administrator and Co-Administrator................................................. 47
Distributor........................................................................ 48
Distribution Plans and Shareholder Servicing
Arrangements for Investor Shares............................................. 49
Investor A Shares........................................................ 49
Investor C Shares........................................................ 50
Investor N Shares........................................................ 51
Information Applicable to Investor A,
Investor C and Investor N Shares............................................. 53
Shareholder Administration Plan
(Primary B Shares)........................................................... 55
Expenses........................................................................... 56
Transfer Agents and Custodian...................................................... 57
INDEPENDENT ACCOUNTANT AND REPORTS...................................................... 58
COUNSEL................................................................................. 58
ADDITIONAL INFORMATION ON PERFORMANCE................................................... 58
Yield Calculations................................................................. 58
Total Return Calculations.......................................................... 59
MISCELLANEOUS........................................................................... 61
Certain Record Holders............................................................. 62
SCHEDULE A - Description of Ratings..................................................... A-1
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SCHEDULE B - Additional Information Concerning
Options & Futures.................................................................. B-1
SCHEDULE C - Additional Information Concerning
Mortgage Backed Securities..................................................... C-1
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INTRODUCTION
Nations Fund Portfolios, Inc. (the "Company") is a mutual fund. The
rules and regulations of the United States Securities and Exchange Commission
(the "SEC") require all mutual funds to furnish prospective investors certain
information concerning the activities of the mutual fund being considered for
investment. This information about the Company is included in various
Prospectuses. The Prospectuses relate to the Primary A (formerly called Trust
A), Primary B (formerly called Trust B), Investor A, Investor C and Investor N
Shares of Nations Emerging Markets Fund (the "Emerging Markets Fund"), Nations
Pacific Growth Fund (the "Pacific Growth Fund") and Nations Global Government
Income Fund (the "Global Government Income Fund") (each, a "Fund" and
collectively, the "Funds"). The Primary A and Primary B Shares are collectively
referred to herein as "Primary Shares" and the Investor A, Investor C and
Investor N Shares are collecting referred to as "Investor Shares." NationsBanc
Advisors, Inc. ("NBAI") is the investment adviser to the Funds. Gartmore Global
Partners ("Gartmore") is sub- investment adviser. As used herein the "Adviser"
shall mean NBAI or Gartmore as the context may require. Prospectuses relating to
the Funds may be obtained without charge by written request to Nations Fund, c/o
Stephens, Inc., One NationsBank Plaza, 33rd Floor, Charlotte, NC 28255.
Investors also may call toll-free at (800) 321-7854.
This SAI is intended to furnish prospective investors with additional
information concerning the Company and the Funds. Some of the information
required to be in this SAI is also included in the Funds' current Prospectuses,
and, in order to avoid repetition, reference will be made to sections of the
Prospectuses. Additionally, the Prospectuses and this SAI omit certain
information contained in the registration statement filed with the SEC. Copies
of the registration statement, including items omitted from the Prospectuses and
this SAI, may be obtained from the SEC by paying the charges prescribed under
its rules and regulations.
FUND TRANSACTIONS AND BROKERAGE
General Brokerage Policy
Subject to policies established by the Board of Directors of the
Company, the Adviser is responsible for decisions to buy and sell securities for
each Fund, for the selection of broker/dealers, for the execution of each Fund's
securities transactions, and for the allocation of brokerage fees in connection
with such transactions. The Adviser's primary consideration in effecting a
security transaction is to obtain the best net price and the most favorable
execution of the order. While the Adviser generally seeks reasonably competitive
commission rates, a Fund does not necessarily pay the lowest commission or
spread available.
The Adviser anticipates that most brokerage services will be provided
by brokerage companies located in London. A portion of the securities in which
the Funds invest are traded in over-the-counter markets, and in such
transactions, a Fund deals directly with the dealers who make markets in the
securities involved, except in those circumstances where better prices and
executions are available elsewhere. Portfolio transactions placed through
dealers serving as primary market makers are effected at net prices, without
commissions as such, but which include compensation in the form of a mark up or
mark down.
The Adviser may from time to time determine target levels of commission
business to transact with various brokers on behalf of its clients (including
the Company) over a certain time
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period. The target levels will be determined based upon the following factors,
among others: (1) the execution services provided by the broker; (2) the
research services provided by the broker; and (3) the broker's attitude toward
and interest in mutual funds in general and in the Company and other mutual
funds advised by the Adviser in particular. No specific formula will be used in
connection with any of the foregoing considerations in determining the target
levels. However, if a broker has indicated a certain level of desired
commissions in return for certain research services provided by the broker, this
factor will be taken into consideration by the Adviser.
Subject to the overall objective of obtaining best price and execution
for the Funds, the Adviser may also consider sales of shares of the Funds and of
the other mutual funds managed or advised by the Adviser as a factor in the
selection of broker/dealers to execute portfolio transactions for the Funds.
The Adviser will seek, whenever possible, to recapture for the benefit
of a Fund any commission, fees, brokerage or similar payments paid by such Fund
on portfolio transactions. Normally, the only fees which may be recaptured are
the soliciting dealer fees on the tender of an account's portfolio securities in
a tender or exchange offer.
The Funds are not under any obligation to deal with any broker or group
of brokers in the execution of transactions in portfolio securities. Brokers who
provide supplemental investment research to the Adviser may receive orders for
transactions by the Funds. Information so received will be in addition to and
not in lieu of the services required to be performed by the Adviser under their
agreements with each Fund and the expenses of the Adviser will not necessarily
be reduced as a result of the receipt of such supplemental information. Certain
research services furnished by broker/dealers may be useful to the Adviser in
connection with their services to other advisory clients, including the
investment companies which they advise. Also, the Funds may pay a higher price
for securities or higher commissions in recognition of research services
furnished by broker/dealers.
The Adviser and its affiliates manage several other investment accounts
some of which may have investment objectives similar to those of one or more of
the Funds. It is possible that, at times, identical securities will be
appropriate for investment by one or more of the Funds and by one or more of
such investment accounts. The position of each account, however, in the
securities of the same issuer may vary and the length of time that each account
may choose to hold its investment in the securities of the same issuer may
likewise vary. The timing and amount of purchase by each account will also be
determined by its cash position. If the purchase or sale of securities
consistent with the investment policies of a Fund and one or more of these
accounts is considered at or about the same time, transactions in such
securities will be allocated among the accounts in a manner deemed equitable by
the Adviser. The Adviser may combine such transactions, in accordance with
applicable laws and regulations, in order to obtain the best net price and most
favorable execution. Simultaneous transactions could, however, adversely affect
the ability of a Fund to obtain or dispose of the full amount of a security
which it seeks to purchase or sell.
In some cases the procedure for allocating securities transactions
among the various investment accounts advised by the Adviser and their
affiliates could have an adverse effect on the price or amount of securities
available to a Fund. In making such allocations, the main factors considered by
the Adviser are the respective investment objectives and policies of such
advisory clients, the relative size of holdings of the same or comparable
securities, the availability of cash
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for investment, the size of investment commitments generally held and the
judgments of the persons responsible for recommending the investment.
Under the Investment Company Act of 1940, as amended (the "1940 Act"),
persons affiliated with the Company are prohibited from dealing with the Company
as principal in the purchase and sale of securities unless an exemptive order
allowing such transactions is obtained from the SEC. Pursuant to an exemption
granted by the SEC, each Fund may engage in transactions involving certain
instruments with Shearson Lehman Brothers, the indirect parent of the Company's
distributor, or particular affiliates of Shearson Lehman Brothers, acting as
principal. Each of the Funds may purchase securities from underwriting
syndicates of which the Adviser or any of its affiliates is a member under
certain conditions, in accordance with the provisions of a rule adopted under
the 1940 Act and any restrictions imposed by the Board of Governors of the
Federal Reserve System.
During the fiscal period ended March 31, 1996, the Company did not pay
brokerage commissions to Stephens, NationsBanc Securities, Inc., NationsBanc
Capital Markets, Inc., Nations Securities or Dean Witter.
As of the fiscal period ended March 31,1996, Emerging Markets Fund and
Global Government Fund did not hold any securities of the Company's regular
brokers or dealers, and Pacific Growth Fund held $1,437,877 in securities issued
by Development Bank of Singapore.
For the fiscal period ended March 31, 1996, Nations Emerging Markets
Fund paid aggregate brokerage commissions of $192,107 and Nations Pacific Growth
Fund paid aggregate brokerage commissions of $638,176.
Section 28(e) Standards
Under Section 28(e) of the Securities Exchange Act of 1934, the Adviser
shall not be "deemed to have acted unlawfully or to have breached its fiduciary
duty" solely because under certain circumstances it has caused the account to
pay a higher commission than the lowest available. To obtain the benefit of
Section 28(e), an adviser must make a good faith determination that the
commissions paid are "reasonable in relation to the value of the brokerage and
research services provided . . . viewed in terms of either that particular
transaction or its overall responsibilities with respect to the accounts as to
which it exercises investment discretion and that the services provided by a
broker provide an adviser with lawful and appropriate assistance in the
performance of its investment decision making responsibilities." Accordingly,
the price to a Fund in any transaction may be less favorable than that available
from another broker/dealer if the difference is reasonably justified by other
aspects of the portfolio execution services offered.
Broker/dealers utilized by the Adviser may furnish statistical,
research and other information or services which are deemed by the Adviser to be
beneficial to the Funds' investment programs. Research services received from
brokers supplement the Adviser's own research and may include the following
types of information: statistical and background information on industry groups
and individual companies; forecasts and interpretations with respect to U.S and
foreign economies, securities, markets, specific industry groups and individual
companies; information on political developments; fund management strategies;
performance information on securities and information concerning prices of
securities; and information supplied by specialized services to the Adviser and
to the Company's directors with respect to the performance, investment
activities and
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fees and expenses of other mutual funds. Such information may be communicated
electronically, orally or in written form. Research services may also include
the providing of equipment used to communicate research information, the
arranging of meetings with management of companies and the providing of access
to consultants who supply research information.
The outside research assistance is useful to the Adviser since the
brokers utilized by the Adviser as a group tend to follow a broader universe of
securities and other matters than the Adviser's staff can follow. In addition,
this research provides the Adviser with a diverse perspective on financial
markets. Research services which are provided to the Adviser by brokers are
available for the benefit of all accounts managed or advised by the Adviser. In
some cases, the research services are available only from the broker providing
such services. In other cases, the research services may be obtainable from
alternative sources in return for cash payments. The Adviser is of the opinion
that because the broker research supplements rather than replaces its research,
the receipt of such research does not tend to decrease its expenses, but tends
to improve the quality of its investment advice. However, to the extent that the
Adviser would have purchased any such research services had such services not
been provided by brokers, the expenses of such services to the Adviser could be
considered to have been reduced accordingly. Certain research services furnished
by broker/dealers may be useful to the Adviser with clients other than the
Funds. Similarly, any research services received by the Adviser through the
placement of fund transactions of other clients may be of value to the Adviser
in fulfilling its obligations to the Funds. The Adviser is of the opinion that
this material is beneficial in supplementing its research and analysis; and,
therefore, it may benefit the Company by improving the quality of the Adviser's
investment advice. The advisory fees paid by the Company are not reduced because
the Adviser receive such services.
Some broker/dealers may indicate that the provision of research
services is dependent upon the generation of certain specified levels of
commissions and underwriting concessions by the Adviser's clients, including the
Funds.
ADDITIONAL INFORMATION ON FUND INVESTMENTS
General
Information concerning each Fund's investment objective is set forth in
each of the Prospectuses under the headings "Objectives," "How Objectives Are
Pursued," and "Appendix A." There can be no assurance that the Funds will
achieve their objectives. The principal features of the Funds' investment
programs and the primary risks associated with those investment programs are
discussed in the Prospectuses under the heading "How Objectives Are Pursued" and
"Appendix A." The values of the securities in which the Funds invest fluctuate
based upon interest rates, foreign currency rates, the financial stability of
the issuer and market factors.
The Funds are dollar-denominated mutual funds and therefore
consideration is given to hedging part or all of the portfolio back to U.S.
dollars from international currencies. All decisions to hedge are based upon an
analysis of the relative value of the U.S. dollar on an international purchasing
power parity basis (purchasing power parity is a method for determining the
relative purchasing power of different currencies by comparing the amount of
each currency required to purchase a typical bundle of goods and services to
domestic markets) and an estimation of short-term interest rate differentials
(which affect both the direction of currency movements and also the cost of
hedging).
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Pursuant to one of the Company's fundamental investment restrictions (see "How
Objectives Are Pursued-Investment Limitations" in the Company's Prospectuses),
the Company does not have authority to purchase any securities which would cause
more than 25% of the value of any Fund's total assets at the time of such
purchase to be invested in the securities of one or more issuers conducting
their principal business activities in the same industry, provided that, there
is no limitation with respect to investments in obligations issued or guaranteed
by the U.S.
Government, its agencies or instrumentalities.
When-lssued Securities
Each Fund may purchase securities on a "when-issued" basis, that is,
the date for delivery of the payment for the securities is not fixed at the date
of purchase, but is set after the securities are issued (normally within 45 days
after the date of the transaction). Each Fund may also purchase or sell
securities on a delayed delivery basis. The payment obligation and the interest
rate that will be received on the when-issued securities are fixed at the time
the buyer enters into the commitment. Each Fund will only make commitments to
purchase when-issued or delayed delivery securities with the intention of
actually acquiring such securities, but each Fund may sell these securities
before the settlement date if it is deemed advisable.
If a Fund purchases a when-issued security, the Fund will direct its
custodian bank to segregate cash or high grade securities in an amount equal to
the when-issued commitment. Segregated securities will be valued at market for
the purpose of determining the adequacy of the segregated securities. If the
market value of such segregated securities declines, additional cash or
securities will be segregated on a daily basis so that the market value of the
segregated securities will equal the amount of the Fund's when-issued
commitments. To the extent funds securities are segregated, they will not be
available for new investment or to meet redemptions.
Securities purchased on a when-issued basis and the securities held in
the Funds are subject to changes in market value based upon the public's
perception of the creditworthiness of the issuer and changes in the level of
interest rates (which will generally result in all of those securities changing
in value in the same way, i.e., experiencing appreciation when interest rates
fall). Therefore, if in order to achieve higher interest income a Fund remains
substantially fully invested at the same time that it has purchased securities
on a when-issued basis, there is a possibility that the Fund will experience
greater fluctuation in the market value of its assets.
Furthermore, when the time comes for a Fund to meet its obligations
under when-issued commitments, the Fund will do so by use of its then available
cash, by the sale of segregated securities, by the sale of other securities or,
although it would not normally expect to do so, by directing the sale of the
when-issued securities themselves (which may have a market value greater or less
than the Fund's payment obligation thereunder). The sale of securities to meet
such obligations carries with it a greater potential for the realization of net
short-term capital gains, which are not exempt from federal income tax. The
value of when-issued securities on the settlement date may be more or less than
the purchase price.
Delayed Delivery Transactions
In a delayed delivery transaction, the Fund relies on the other party
to complete the transaction. If the transaction is not completed, the Fund may
miss a price or yield considered to be advantageous.
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Foreign Currency Transactions
As described in the Prospectuses, the Funds may invest in foreign
currency transactions. Foreign securities involve currency risks. The U.S.
dollar value of a foreign security tends to decrease when the value of the U.S.
dollar rises against the foreign currency in which the security is denominated,
and tends to increase when the value of the U.S. dollar falls against such
currency. A Fund may purchase or sell forward foreign currency exchange
contracts ("forward contracts") to attempt to minimize the risk to the Fund from
adverse changes in the relationship between the U.S. dollar and foreign
currencies. A Fund may also purchase and sell foreign currency futures contracts
and related options (see "Purchase and Sale of Currency Futures Contracts and
Related Options"). A forward contract is an obligation to purchase or sell a
specific currency for an agreed price at a future date that is individually
negotiated and privately traded by currency traders and their customers.
Forward foreign currency exchange contracts establish an exchange rate
at a future date. These contracts are transferable in the interbank market
conducted directly between currency traders (usually large commercial banks) and
their customers. A forward foreign currency exchange contract generally has no
deposit requirement, and is traded at a net price without commission. A Fund
will direct its custodian to segregate high grade liquid assets in an amount at
least equal to its obligations under each forward foreign currency exchange
contract. Neither spot transactions nor forward foreign currency exchange
contracts eliminate fluctuations in the prices of a Fund's portfolio securities
or in foreign exchange rates, or prevent loss if the prices of these securities
should decline.
A Fund may enter into a forward contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of the security (a
"transaction hedge"). In addition, when the Adviser believes that a foreign
currency may suffer a substantial decline against the U.S. dollar, it may enter
into a forward sale contract to sell an amount of that foreign currency
approximating the value of some or all of the Fund's securities denominated in
such foreign currency, or when the Adviser believe that the U.S. dollar may
suffer a substantial decline against the foreign currency, it may enter into a
forward purchase contract to buy that foreign currency for a fixed dollar amount
(a "position hedge").
A Fund may, in the alternative, enter into a forward contract to sell a
different foreign currency for a fixed U.S. dollar amount where the Adviser
believes that the U.S. dollar value of the currency to be sold pursuant to the
forward contract will fall whenever there is a decline in the U.S. dollar value
of the currency in which the fund securities are denominated (a "cross-hedge").
Foreign currency hedging transactions are an attempt to protect a Fund
against changes in foreign currency exchange rates between the trade and
settlement dates of specific securities transactions or changes in foreign
currency exchange rates that would adversely affect a portfolio position or an
anticipated portfolio position. Although these transactions tend to minimize the
risk of loss due to a decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be realized should the
value of the hedged currency increase. The precise matching of the forward
contract amount and the value of the securities involved will not generally be
possible because the future value of these securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date the forward contract is entered into and date it matures.
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The Funds' custodian will segregate cash, U.S. Government securities or other
high-quality debt securities having a value equal to the aggregate amount of the
Fund's commitments under forward contracts entered into with respect to position
hedges and cross-hedges. If the value of the segregated securities declines,
additional cash or securities will be segregated on a daily basis so that the
value of the segregated securities will equal the amount of the Fund's
commitments with respect to such contracts. As an alternative to segregating all
or part of such securities, the Fund may purchase a call option permitting the
Fund to purchase the amount of foreign currency being hedged by a forward sale
contract at a price no higher than the forward contract price or the Fund may
purchase a put option permitting the Fund to sell the amount of foreign currency
subject to a forward purchase contract at a price as high or higher than the
forward contract price.
Futures, Options and Other Derivative Instruments
Futures Contracts in General. A futures contract is an agreement
between two parties for the future delivery of fixed income securities or for
the payment or acceptance of a cash settlement in the case of futures contracts
on an index of fixed income or equity securities. A "sale" of a futures contract
means the contractual obligation to deliver the securities at a specified price
on a specified date, or to make the cash settlement called for by the contract.
Futures contracts have been designed by exchanges which have been designated
"contract markets" by the Commodity Futures Trading Commission ("CFTC") and must
be executed through a brokerage firm, known as a futures commission merchant,
which is a member of the relevant contract market. Futures contracts trade on
these markets, and the exchanges, through their clearing organizations,
guarantee that the contracts will be performed as between the clearing members
of the exchange. Presently, futures contracts are based on such debt securities
as long-term U.S. Treasury Bonds, Treasury Notes, Government National Mortgage
Association modified pass-through mortgage-backed securities, three-month U.S.
Treasury Bills, bank certificates of deposit, and on indices of municipal,
corporate and government bonds.
While futures contracts based on securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are very seldom
made. Generally, a futures contract is terminated by entering into an offsetting
transaction. A Fund will incur brokerage fees when it purchases and sells
futures contracts. At the time such a purchase or sale is made, a Fund must
provide cash or money market securities as a deposit known as "margin." The
initial deposit required will vary, but may be as low as 2% or less of a
contract's face value. Daily thereafter, the futures contract is valued through
a process known as "marking to market," and a Fund that engages in futures
transactions may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable. At the time of delivery of securities
pursuant to a futures contract based on securities, adjustments are made to
recognize differences in value arising from the delivery of securities with a
different interest rate than the specific security that provides the standard
for the contract. In some (but not many) cases, securities called for by a
futures contract may not have been issued when the contract was written.
Futures contracts on indices of securities are settled through the
making and acceptance of cash settlements based on changes in value of the
underlying rate or index between the time the contract is entered into and the
time it is liquidated.
Futures Contracts on Fixed Income Securities and Related Indices. As
noted in their respective Prospectuses, the Funds may enter into transactions
in futures contracts for the purpose
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of hedging a relevant portion of their portfolios. A Fund may enter into
transactions in futures contracts that are based on obligations issued or
guaranteed as to payment of principal and interest by the U.S. Government, it
agencies or instrumentalities ("U.S. Government Obligations"), including any
index of government obligations that may be available for trading. Such
transactions will be entered into where movements in the value of the securities
or index underlying a futures contract can be expected to correlate closely with
movements in the value of securities held in a Fund. For example, a Fund may
sell futures contracts in anticipation of a general rise in the level of
interest rates, which would result in a decline in the value of its fixed income
securities. If the expected rise in interest rates occurs, the Fund may realize
gains on its futures position, which should offset all or part of the decline in
value of fixed income fund securities. A Fund could protect against such decline
by selling fixed income securities, but such a strategy would involve higher
transaction costs than the sale of futures contracts and, if interest rates
again declined, the Fund would be unable to take advantage of the resulting
market advance without purchases of additional securities.
The purpose of the purchase or sale of a futures contract on government
securities and indices of government securities, in the case of the Funds, which
hold or intend to acquire long-term debt securities, is to protect a Fund from
fluctuations in interest rates without actually buying or selling long-term debt
securities. For example, if long-term bonds are held by a Fund, and interest
rates were expected to increase, the Fund might enter into futures contracts for
the sale of debt securities. Such a sale would have much the same effect as
selling an equivalent value of the long-term bonds held by the Fund. If interest
rates did increase, the value of the debt securities in the Fund would decline,
but the value of the futures contracts to the Fund would increase at
approximately the same rate thereby keeping the net asset value of the Fund from
declining as much as it otherwise would have. When a Fund is not fully invested
and a decline in interest rates is anticipated, which would increase the cost of
fixed income securities that the Fund intends to acquire, it may purchase
futures contracts. In the event that the projected decline in interest rates
occurs, the increased cost of the securities acquired by the Fund should be
offset, in whole or part, by gains on the futures contracts by entering into
offsetting transactions on the contract market on which the initial purchase was
effected. In a substantial majority of transactions involving futures contracts
on fixed income securities, a Fund will purchase the securities upon termination
of the long futures positions, but under unusual market conditions, a long
futures position may be terminated without a corresponding purchase of
securities.
Similarly, when it is expected that interest rates may decline, futures
contracts on fixed income securities and indices of government securities may be
purchased for the purpose of hedging against anticipated purchases of long-term
bonds at higher prices. Since the fluctuations in the value of such futures
contracts should be similar to that of long-term bonds, a Fund could take
advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Fund's cash reserves could then be used to
buy long-term bonds in the cash market. Similar results could be accomplished by
selling bonds with long maturities and investing in bonds with short maturities
when interest rates are expected to increase. However, since the futures market
is more liquid than the cash market, the use of these futures contracts as an
investment technique allows a Fund to act in anticipation of such an interest
rate decline without having to sell its portfolio securities. To the extent a
Fund enters into futures contracts for this purpose, the segregated assets
maintained by a Fund will consist of cash, cash equivalents or high quality debt
securities of the Fund in an amount equal to the difference between the
fluctuating market value of such futures
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contracts and the aggregate value of the initial deposit and variation margin
payments made by the Fund with respect to such futures contracts.
Stock Index Futures Contracts. As described in the Prospectuses, the
Funds may sell stock index futures contracts in order to offset a decrease in
market value of its securities that might otherwise result from a market
decline. A Fund may do so either to hedge the value of its portfolio as a whole,
or to protect against declines, occurring prior to sales of securities, in the
value of securities to be sold. Conversely, a Fund may purchase stock index
futures contracts in order to protect against anticipated increases in the cost
of securities to be acquired.
In addition, a Fund may utilize stock index futures contracts in
anticipation of changes in the composition of its portfolio. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its portfolio, it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. As such securities
are acquired, a Fund's futures positions would be closed out. A Fund may also
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of its portfolio will decline prior to the time of sale.
Options on Futures Contracts. An option on a futures contract gives the
purchaser (the "holder") the right, but not the obligation, to enter into a
"long" position in the underlying futures contract (i.e., a purchase of such
futures contract) in the case of an option to purchase (a "call" option), or a
"short" position in the underlying futures contract (i.e., a sale of such
futures contract) in the case of an option to sell (a "put" option), at a fixed
price (the "strike price") up to a stated expiration date. The holder pays a
non-refundable purchase price for the option, known as the "premium." The
maximum amount of risk the purchase of the option assumes is equal to the
premium plus related transaction costs, although this entire amount may be lost.
Upon exercise of the option by the holder, the exchange clearing corporation
establishes a corresponding long position in the case of a put option. In the
event that an option is exercised, the parties will be subject to all the risks
associated with the trading of futures contracts, such as payment of variation
margin deposits. In addition, the writer of an option on a futures contract,
unlike the holder, is subject to initial and variation margin requirements on
the option position.
Options on Futures Contracts on Fixed Income Securities and Restated
Indices. As described in the Prospectuses, the Funds may purchase put options on
futures contracts in which the Funds are permitted to invest for the purpose of
hedging a relevant portion of their portfolios against an anticipated decline in
the values of portfolio securities resulting from increases in interest rates,
and may purchase call options on such futures contracts as a hedge against an
interest rate decline when they are not fully invested. A Fund would write
options on these futures contracts primarily for the purpose of terminating
existing positions.
Options on Stock Index Futures Contracts, Options on Stock Indices and
Options on Equity Securities. As described in the Prospectuses, the Funds may
purchase put options on stock index futures contracts, stock indices or equity
securities for the purpose of hedging the relevant portion of its portfolio
securities against an anticipated market-wide decline or against declines in the
values of individual portfolio securities, and it may purchase call options on
such futures contracts as a hedge against a market advance when it is not fully
invested. A Fund would write options on such futures contracts primarily for the
purpose of termination existing positions. In general, options on stock indices
will be employed in lieu of options on stock index futures
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contracts only where they present an opportunity to hedge at lower cost. With
respect to options on equity securities, a Fund may, under certain
circumstances, purchase a combination of call options on such securities and
U.S. Treasury bills. The Adviser believes that such a combination may more
closely parallel movements in the value of the security underlying the call
option than would the option itself.
Further, while a Fund generally would not write options on individual
portfolio securities, it may do so under limited circumstances known as
"targeted sales" and "targeted buys," which involve the writing of call or put
options in an attempt to purchase or sell portfolio securities at specific
desired prices. A Fund would receive a fee, or a "premium," for the writing of
the option. For example, where the Fund seeks to sell portfolio securities at a
"targeted" price, it may write a call option at that price. In the event that
the market rises above the exercise price, it would receive its "targeted"
price, upon the exercise of the option, as well as the premium income. Also,
where it seeks to buy portfolio securities at a "targeted" price, it may write a
put option at that price for which it will receive the premium income. In the
event that the market declines below the exercise price, a Fund would pay its
"targeted" price upon the exercise of the option. In the event that the market
does not move in the direction or to the extent anticipated, however, the
targeted sale or buy might not be successful and a Fund could sustain a loss on
the transaction that may not be offset by the premium received. In addition, a
Fund may be required to forego the benefit of an intervening increase or decline
in value of the underlying security.
Options and Futures Strategies. The Adviser may seek to increase the
current return of a Fund by writing covered call or put options. In addition,
through the writing and purchase of options and the purchase and sale of U.S.
and certain foreign stock index futures contracts, interest rate futures
contracts, foreign currency futures contracts and related options on such
futures contracts, the Adviser may at times seek to hedge against a decline in
the value of securities included in the Fund or an increase in the price of
securities that it plans to purchase for the Fund. Expenses and losses incurred
as a result of such hedging strategies will reduce the Fund's current return. A
Fund's investment in foreign stock index futures contracts and foreign interest
rate futures contracts, and related options on such futures contracts, are
limited to only those contracts and related options that have been approved by
the CFTC for investment by U.S. Investors. Additionally, with respect to a
Fund's investment in foreign options, unless such options are specifically
authorized for investment by order of the CFTC or meet the definition of "trade
option" as set forth in CFTC rule 32.4, a Fund will not make these investments.
The ability of a Fund to engage in the options and futures strategies
described below will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to stock indices,
foreign government securities and foreign currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no assurance
can be given that a Fund will be able to utilize these instruments effectively
for the purposes stated below. Furthermore, a Fund's ability to engage in
options and futures transactions may be limited by tax considerations. Although
a Fund will only engage in options and futures transactions for limited
purposes, these activities will involve certain risks which are described below
under "Risk Factors Associated with Futures and Options Transactions." A Fund
will not engage in options and futures transactions for leveraging purposes.
Writing Covered Options on Securities. A Fund may write covered call
options and covered put options on optionable securities of the types in which
it is permitted to invest from time
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to time as the Adviser determines is appropriate in seeking to attain its
objective. Call options written by a Fund give the holder the right to buy the
underlying securities from a Fund at a stated exercise price; put options give
the holder the right to sell the underlying security to the Fund at a stated
price.
A Fund may write only covered options, which means that, so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option (or comparable securities satisfying the cover
requirements of securities exchanges). In the case of put options, a Fund will
maintain in a separate account cash or short-term U.S. Government securities
with a value equal to or greater than the exercise price of the underlying
securities. A Fund may also write combinations of covered puts and calls on the
same underlying security.
A Fund will receive a premium from writing a put or call option, which
increases the Fund's return in the event the option expires unexercised or is
closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price of the underlying security to the
exercise price of the option, the term of the option and the volatility of the
market price of the underlying security. By writing a call option, a Fund limits
its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option. By writing a put
option, the Fund 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 if the purchase price exceeds the
market value plus the amount of the premium received, unless the security
subsequently appreciates in value.
A Fund may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written. A Fund will realize a
profit or loss from such transaction if the cost of such transaction is less or
more than the premium received from the writing of the option. In the case of a
put option, any loss so incurred may be partially or entirely offset by the
premium received from a simultaneous or subsequent sale of a different put
option. 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 the repurchase of a call option is likely to be offset in whole
or in part by unrealized appreciation of the underlying security owned by a
Fund.
Purchasing Put and Call Options on Securities. A Fund may purchase put
options to protect its portfolio holdings in an underlying security against a
decline in market value. Such hedge protection is provided during the life of
the put option since a Fund, as holder of the put option, is able to sell the
underlying security at the put exercise price regardless of any decline in the
underlying security's 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. By using put options
in this manner, a Fund will reduce any profit it might otherwise have realized
in its underlying security by the premium paid for the put option and by
transaction costs.
A Fund may also purchase call options to hedge against an increase in
prices of securities that it wants ultimately to buy. Such hedge protection is
provided during the life of the call option since the Fund, 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. By using call options in this manner, a
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Fund will reduce any profit it might have realized had it bought the underlying
security at the time it purchased the call option by the premium paid for the
call option and by transaction costs.
Purchase and Sale of Options and Futures on Stock Indices. A Fund may
purchase and sell options on non-U.S. stock indices and stock index futures as
a hedge against movements in the equity markets.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such difference between the closing price of the index and the exercise
price of the option expressed in dollars multiplied by a specified multiple. The
writer of the option is obligated, in return for the premium received, to make
delivery of this amount. Unlike options on specific securities, all settlements
of options on stock indices are in cash and gain or loss depends on general
movements in the stocks included in the index rather than price movements in
particular stocks. A stock index futures contract is an agreement in which one
party agrees to deliver to the other an amount of cash equal to a specific
amount multiplied by the difference between the value of a specific stock index
at the close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of securities is made.
If the Adviser expects general stock market prices to rise, a Fund
might purchase a call option on a stock index or a futures contract on that
index as a hedge against an increase in prices of particular equity securities
it wants ultimately to buy. If in fact the stock index does rise, the price of
the particular equity securities intended to be purchased may also increase, but
that increase would be offset in part by the increase in the value of a Fund's
index option or futures contract resulting from the increase in the index. If,
on the other hand, the Adviser expects general stock market prices to decline, a
Fund might purchase a put option or sell a futures contract on the index. If
that index does in fact decline, the value of some or all of the equity
securities in a Fund may also be expected to decline, but that decrease would be
offset in part by the increase in the value of the Fund's position in such put
option or futures contract.
Purchase and Sale of Interest Rate Futures. A Fund may purchase and
sell interest rate futures contracts on foreign government securities for the
purpose of hedging fixed income and interest sensitive securities against the
adverse effects of anticipated movements in interest rates.
A Fund may sell interest rate futures contracts in anticipation of an
increase in the general level of interest rates. Generally, as interest rates
rise, the market value of the fixed income securities held by a Fund will fall,
thus reducing the net asset value of the Fund. This interest rate risk can be
reduced without employing futures as a hedge by selling long-term fixed income
securities and either reinvesting the proceeds in securities with shorter
maturities or by holding assets in cash. This strategy, however, entails
increased transaction costs to a Fund in the form of dealer spreads and
brokerage commissions.
The sale of interest rate futures contracts provides an alternative
means of hedging against rising interest rates. As rates increase, the value of
a Fund's short position in the futures contracts will also tend to increase,
thus offsetting all or a portion of the depreciation in the market value of a
Fund's investments that are being hedged. While a Fund will incur commission
expenses in selling
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and closing out futures positions (which is done by taking an opposite position
which operates to terminate the position in the futures contract), commissions
on futures transactions are lower than transaction costs incurred in the
purchase and sale of portfolio securities.
Options on Stock Index Futures Contracts and Interest Rate Futures
Contracts. A Fund may purchase and write call and put options on non-U.S. stock
index and interest rate futures contracts. A Fund may use such options on
futures contracts in connection with its hedging strategies in lieu of
purchasing and writing options directly on the underlying securities or stock
indices or purchasing and selling the underlying futures. For example, a Fund
may purchase put options or write call options on stock index futures, or
interest rate futures, rather than selling futures contracts, in anticipation of
a decline in general stock market prices or rise in interest rates,
respectively, or purchase call options or write put options on stock index or
interest rate futures, rather than purchasing such futures, to hedge against
possible increases in the price of equity securities or debt securities,
respectively, which the Fund intends to purchase.
Purchase and Sale of Currency Futures Contracts and Related Options. In
order to hedge its portfolio and to protect it against possible variations in
foreign exchange rates pending the settlement of securities transactions, a Fund
may buy or sell currency futures contracts and related options. If a fall in
exchange rates for a particular currency is anticipated, a Fund may sell a
currency futures contract or a call option thereon or purchase a put option on
such futures contract as a hedge. If it is anticipated that exchange rates will
rise, a Fund may purchase a currency futures contract or a call option thereon
or sell (write) a put option to protect against an increase in the price of
securities denominated in a particular currency a Fund intends to purchase.
These futures contracts and related options thereon will be used only as a hedge
against anticipated currency rate changes, and all options on currency futures
written by a Fund will be covered.
A currency futures contract sale creates an obligation by a Fund, as
seller, to deliver the amount of currency called for in the contract at a
specified futures time for a special price. A currency futures contract purchase
creates an obligation by a Fund, as purchaser, to take delivery of an amount of
currency at a specified future time at a specified price. Although the terms of
currency futures contracts specify actual delivery or receipt, in most instances
the contracts are closed out before the settlement date without the making or
taking of delivery of the currency. Closing out of a currency futures contract
is effected by entering into an offsetting purchase or sale transaction. Unlike
a currency futures contract, which requires the parties to buy and sell currency
on a set date, an option on a currency futures contract entitles its holder to
decide on or before a future date whether to enter into such a contract. If the
holder decides not to enter into the contract, the premium paid for the option
is fixed at the point of sale.
The Funds will write (sell) only covered put and call options on
currency futures. This means that a Fund will provide for its obligations upon
exercise of the option by segregating sufficient cash or short-term obligations
or by holding an offsetting position in the option or underlying currency
future, or a combination of the foregoing. A Fund will, so long as it is
obligated as the writer or a call option on currency futures, own on a
contract-for-contract basis an equal long position in currency futures with the
same delivery date or a call option on stock index futures with the difference,
if any, between the market value of the call written and the market value of the
call or long currency futures purchased maintained by a Fund in cash, Treasury
bills, or other high-grade short-term obligations in a segregated account with
its custodian. If at the close of business on any day the market value of the
call purchased by a Fund falls below 100% of the market value of the call
written by the Fund, a Fund will so segregate an amount of cash, Treasury
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bills or other high grade short-term obligations equal in value to the
difference. Alternatively, a Fund may cover the call option through segregating
with the custodian an amount of the particular foreign currency equal to the
amount of foreign currency per futures contract option times the number of
options written by a Fund. In the case of put options on currency futures
written by the Fund, the Fund will hold the aggregate exercise price in cash,
Treasury bills, or other high grade short-term obligations in a segregated
account with its custodian, or own put options on currency futures or short
currency futures, with the difference, if any, between the market value of the
puts written and the market value of the puts purchased or the currency futures
sold maintained by a Fund in cash, Treasury bills or other high grade short-term
obligations in a segregated account with its custodian. If at the close of
business on any day the market value of the put options purchased or the
currency futures by a Fund falls below 100% of the market value of the put
options written by a Fund, the Fund will so segregate an amount of cash,
Treasury bills or other high grade short-term obligations equal in value to the
difference.
If other methods of providing appropriate cover are developed, a Fund
reserves the right to employ them to the extent consistent with applicable
regulatory and exchange requirements. In connection with transactions in stock
index options, stock index futures, interest rate futures, foreign currency
futures and related options on such futures, a Fund will be required to deposit
as "initial margin" an amount of cash or short-term government securities equal
to from 5% to 8% of the contract amount. Thereafter, subsequent payments
(referred to as "variation margin") are made to and from the broker to reflect
changes in the value of the futures contract.
Limitations on Purchase of Options. The staff of the SEC has taken the
position that purchased over-the-counter options and assets used to cover
written over-the-counter options are illiquid and, therefore, together with
other illiquid securities, cannot exceed 15% of a Fund's assets. The Adviser
intends to limit a Fund's writing of over-the-counter options in accordance with
the following procedure. Each Fund intends to write over-the-counter options
only with primary U.S. Government securities dealers recognized by the Federal
Reserve Bank of New York. Also, the contracts which a Fund has in place with
such primary dealers will provide that the Fund has the
absolute right to repurchase an option it writes at any time at a price which
represents the fair market value, as determined in good faith through
negotiation between the parties, but which in no event will exceed a price
determined pursuant to a formula in the contract. Although the specific formula
may vary between contracts with different primary dealers, the formula will
generally be based on a multiple of the premium received by a Fund for writing
the option, plus the amount, if any, of the option's intrinsic value (i.e., the
amount that the option is in-the-money). The formula also may include a factor
to account for the difference between the price of the security and the strike
price of the option if the option is written out-of-the-money. A Fund will treat
all or a part of the formula price as illiquid for purposes of the 15% test
imposed by the SEC staff.
Risk Factors Associated with Futures and Options Transactions
The effective use of options and futures strategies depends on, among
other things, a Fund's ability to terminate options and futures positions at
times when its the Adviser deems it desirable to do so. Although a Fund will not
enter into an option or futures position unless the Adviser believes that a
liquid secondary market exists for such option or future, there is no assurance
that a Fund will be able to effect closing transactions at any particular time
or at an acceptable price. A Fund generally expects that its options and futures
transactions will be conducted on recognized U.S. and foreign securities and
commodity exchanges. In certain instances, however, a Fund may purchase and sell
options in the over-the-counter market. A
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Fund's ability to terminate option positions established in the over-the-counter
market may be more limited than in the case of exchange-traded options and may
also involve the risk that securities dealers participating in such transactions
would fail to meet their obligations to the Fund.
Options and futures markets can be highly volatile and transactions of
this type carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these types of transactions may result not only in loss
of the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of options and futures involves the risk of imperfect
correlation between movements in options and futures prices and movements in the
price of securities which are the subject of the hedge. Such correlation,
particularly with respect to options on stock indices and stock index futures,
is imperfect, and such risk increases as the composition of a Fund diverges from
the composition of the relevant index. The successful use of these strategies
also depends on the ability of the Adviser to correctly forecast interest rate
movements, currency rate movements and general stock market price movements.
In addition to certain risk factors described above, the following sets
forth certain information regarding the potential risks associated with the
Funds' futures and options transactions.
Risk of Imperfect Correlation. A Fund's ability effectively to hedge
all or a portion of its portfolio through transactions in futures, options on
futures or options on stock indices depends on the degree to which movements in
the value of the securities or index underlying such hedging instrument
correlate with movements in the value of the relevant portion of the Fund's
securities. If the values of the securities being hedged do not move in the same
amount or direction as the underlying security or index, the hedging strategy
for a Fund might not be successful and the Fund could sustain losses on its
hedging transactions which would not be offset by gains on its portfolio. It is
also possible that there may be a negative correlation between the security or
index underlying a futures or option contract and the portfolio securities being
hedged, which could result in losses both on the hedging transaction and the
fund securities. In such instances, a Fund's overall return could be less than
if the hedging transactions had not been undertaken. Stock index futures or
options based on a narrower index of securities may present greater risk than
options or futures based on a broad market index, as a narrower index is more
susceptible to rapid and extreme fluctuations resulting from changes in the
value of a small number of securities. A Fund would, however, effect
transactions in such futures or options only for hedging purposes.
The trading of futures and options on indices involves the additional
risk of imperfect correlation between movements in the futures or option price
and the value of the underlying index. The anticipated spread between the prices
may be distorted due to differences in the nature of the markets, such as
differences in margin requirements, the liquidity of such markets and the
participation of speculators in the futures and options market. The purchase of
an option on a futures contract also involves the risk that changes in the value
of underlying futures contract will not be fully reflected in the value of the
option purchased. The risk of imperfect correlation, however, generally tends to
diminish as the maturity date of the futures contract or termination date of the
option approaches. The risk incurred in purchasing an option on a futures
contract is limited to the amount of the premium plus related transaction costs,
although it may be necessary under certain circumstances to exercise the option
and enter into the underlying futures contract in order to realize a profit.
Under certain extreme market conditions, it is possible that a Fund will not be
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able to establish hedging positions, or that any hedging strategy adopted will
be insufficient to completely protect the Fund.
A Fund will purchase or sell futures contracts or options only if, in
the Adviser's judgment, there is expected to be a sufficient degree of
correlation between movements in the value of such instruments and changes in
the value of the relevant portion of the Fund's portfolio for the hedge to be
effective. There can be no assurance that the Adviser's judgment will be
accurate.
Potential Lack of a Liquid Secondary Market. The ordinary spreads
between prices in the cash and futures markets, due to differences in the
natures of those markets, are subject to distortions. First, all participants in
the futures market are subject to initial deposit and variation margin
requirements. This could require a Fund to post additional cash or cash
equivalents as the value of the position fluctuates. Further, rather than
meeting additional variation margin requirements, investors may close futures
contracts through offsetting transactions which could distort the normal
relationship between the cash and futures markets. Second, the liquidity of the
futures or options market may be lacking. Prior to exercise or expiration, a
futures or option position may be terminated only by entering into a closing
purchase or sale transaction, which requires a secondary market on the exchange
on which the position was originally established. While a Fund will establish a
futures or option position only if there appears to be a liquid secondary market
therefor, there can be no assurance that such a market will exist for any
particular futures or option contract at any specific time. In such event, it
may not be possible to close out a position held by a Fund, which could require
the Fund to purchase or sell the instrument underlying the position, make or
receive a cash settlement, or meet ongoing variation margin requirements. The
inability to close out futures or option positions also could have an adverse
impact on a Fund's ability effectively to hedge its securities, or the relevant
portion thereof.
The liquidity of a secondary market in a futures contract or an option
on a futures contract may be adversely affected by "daily price fluctuation
limits" established by the exchanges, which limit the amount of fluctuation in
the price of a contract during a single trading day and prohibit trading beyond
such limits once they have been reached. The trading of futures and options
contracts also is subject to the risk of trading halts, suspensions, exchange or
clearing house equipment failures, government intervention, insolvency of the
brokerage firm or clearing house or other disruptions of normal trading
activity, which could at times make it difficult or impossible to liquidate
existing positions or to recover excess variation margin payments.
Risk of Predicting Interest Rate Movements. Investments in futures
contracts on fixed income securities and related indices involve the risk that
if the Adviser's investment judgment concerning the general direction of
interest rates is incorrect, a Fund's overall performance may be poorer than if
it had not entered into any such contract. For example, if a Fund has been
hedged against the possibility of an increase in interest rates which would
adversely affect the price of bonds held in its portfolio and interest rates
decrease instead, the Fund will lose part or all of the benefit of the increased
value of its bonds which have been hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if a Fund has
insufficient cash, it may have to sell bonds from its portfolio to meet daily
variation margin requirements, possibly at a time when it may be disadvantageous
to do so. Such sale of bonds may be, but will not necessarily be, at increased
prices which reflect the rising market.
Trading and Position Limits. Each contract market on which futures
and option contracts are traded has established a number of limitations
governing the maximum number of positions
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which may be held by a trader, whether acting alone or in concert with others.
The Adviser does not believe that these trading and position limits will have an
adverse impact on the hedging strategies regarding the Funds' investments.
Regulations on the Use of Futures and Options Contracts. Regulations of
the CFTC require that the Funds enter into transactions in futures contracts and
options thereon for hedging purposes only, in order to assure that they are not
deemed to be a "commodity pool" under such regulations. In particular, CFTC
regulations require that all short futures positions be entered into for the
purpose of hedging the value of investment securities held by a Fund, and that
all long futures positions either constitute bona fide hedging transactions, as
defined in such regulations, or have a total value not in excess of an amount
determined by reference to certain cash and securities positions maintained for
the Fund, and accrued profits on such positions. In addition, a Fund may not
purchase or sell such instruments if, immediately thereafter, the sum of the
amount of initial margin deposits on its existing futures positions and premiums
paid for options on futures contracts would exceed 5% of the market value of the
Fund's total assets.
When a Fund purchases a futures contract, an amount of cash or cash
equivalents or high quality debt securities will be segregated with the Fund's
custodian so that the amount so segregated, plus the initial deposit and
variation margin held in the account of its broker, will at all times equal the
value of the futures contract, thereby insuring that the use of such futures is
unleveraged.
The Funds' ability to engage in the hedging transactions described
herein may be limited by the current federal income tax requirement that a Fund
derive less than 30% of its gross income from the sale or other disposition of
stock or securities held for less than three months. The Funds may also further
limit their ability to engage in such transactions in response to the policies
and concerns of various Federal and state regulatory agencies. Such policies may
be changed by vote of the Board of Directors.
Interest Rate Transactions
Among the strategic transactions into which a Fund may enter are
interest rate swaps and the purchase or sale of related caps and floors. The
Funds expect to 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 the Fund anticipates purchasing
at a later date. Each Fund intends to 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
Fund may be obligated to pay. Interest rate swaps involve the exchange by a Fund
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 and 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 floor to the extent that a
specified index falls below a predetermined interest rate or amount.
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A Fund 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 Fund receiving or paying, as the case may
be, only the net amount of the two payments. Inasmuch as these swaps, caps and
floors are entered into for good faith hedging purposes, the Adviser and the
Funds believe such obligations do not constitute senior securities under the
1940 Act and, accordingly, will not treat them as being subject to its borrowing
restrictions. A Fund will not enter into any swap, cap and floor transaction
unless, at the time of entering into such transaction, the unsecured long-term
debt of the counterparty, combined with any credit enhancements, is rated at
least "A" by Standard & Poor's Corporation or Moody's Investors Service, Inc. or
has an equivalent rating from a nationally recognized statistical rating
organization ("NRSRO") or is determined to be of equivalent credit quality by
the Adviser. If there is a default by the counterparty, the Fund 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 both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps and floors 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, a Fund 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 an amount of cash or liquid high grade securities
having a value equal to the accrued excess. Caps and floors require segregation
of assets with a value equal to the Fund's net obligation, if any.
Asset-Backed Securities
In General. Asset-backed securities arise through the grouping by
governmental, government- related, and private organizations of loans,
receivables, or other assets originated by various lenders. Asset-backed
securities consist of both mortgage- and non-mortgage-backed securities.
Interests in pools of these assets may differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal paid at maturity or specified call dates. Conversely,
asset-backed securities provide periodic payments which may consist of both
interest and principal payments.
The life of an asset-backed security varies depending upon rate of the
prepayment of the underlying debt instruments. The rate of such prepayments will
be a function of current market interest rates, and other economic and
demographic factors. For example, falling interest rates generally result in an
increase in the rate of prepayments of mortgage loans while rising interest
rates generally decrease the rate of prepayments. An acceleration in prepayments
in response to sharply falling interest rates will shorten the security's
average maturity and limit the potential appreciation in the security's value
relative to a conventional debt security. Consequently, asset- backed securities
may not be as effective in locking in high, long-term yields. Conversely, in
periods of sharply rising rates, prepayments are generally slow, increasing the
security's average life and its potential for price depreciation.
Mortgage-Backed Securities. Mortgage-backed securities represent an
ownership interest in a pool of mortgage loans.
Mortgage pass-through securities may represent participation interests
in pools of residential mortgage loans originated by U.S. governmental or
private lenders and guaranteed, to the extent
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provided in such securities, by the U.S. Government or one of its agencies,
authorities or instrumentalities. Such securities, which are ownership interests
in the underlying mortgage loans, differ from conventional debt securities,
which provide for periodic payment of interest in fixed amounts (usually
semi-annually) and principal payments at maturity or on specified call dates.
Mortgage pass-through securities provide for monthly payments that are a
"pass-through" of the monthly interest and principal payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans, net
of any fees paid to the guarantor of such securities and the servicer of the
underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Fund may invest
may include those issued or guaranteed by GNMA, FNMA and FHLMC. Such
Certificates are mortgage-backed securities which represent a partial ownership
interest in a pool of mortgage loans issued by lenders such as mortgage bankers,
commercial banks and savings and loan associations. Such mortgage loans may have
fixed or adjustable rates of interest.
The average life of a mortgage-backed security is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities. Prepayments of principal by mortgagors and mortgage foreclosures
will usually result in the return of the greater part of principal invested far
in advance of the maturity of the mortgages in the pool.
The yield which will be earned on mortgage-backed securities may vary from
their coupon rates for the following reasons: (i) Certificates may be issued at
a premium or discount, rather than at par; (ii) Certificates may trade in the
secondary market at a premium or discount after issuance; (iii) interest is
earned and compounded monthly, which has the effect of raising the effective
yield earned on the Certificates; and (iv) the actual yield of each Certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the Certificates and the rate at which principal so prepaid is
reinvested. In addition, prepayment of mortgages included in the mortgage pool
underlying a GNMA Certificate purchased at a premium may result in a loss to the
Fund.
Mortgage-backed securities issued by private issuers, whether or not such
obligations are subject to guarantees by the private issuer, may entail greater
risk than obligations directly or indirectly guaranteed by the U.S. Government.
Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (collateral
collectively hereinafter referred to as "Mortgage Assets"). Multi-class
pass-through securities are interests in a trust composed of Mortgage Assets and
all references herein to CMOs will include multi-class pass-through securities.
Payments of principal of and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distribution on the multi- class pass-through securities.
Moreover, principal prepayments on the Mortgage Assets may cause the CMOs
to be retired substantially earlier than their stated maturities or final
distribution dates, resulting in a loss of all or part of the premium if any has
been paid. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semiannual basis.
The principal and interest payments on the Mortgage Assets may be
allocated among the various classes of CMOs in several ways. Typically, payments
of principal, including any prepayments, on the underlying mortgages are applied
to the classes in the order of
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their respective stated maturities or final distribution dates, so that no
payment of principal is made on CMOs of a class until all CMOs of other classes
having earlier stated maturities or final distribution dates have been paid in
full.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class
mortgage securities. A Fund will only invest in SMBS that are obligations backed
by the full faith and credit of the U.S. Government. SMBS are usually structured
with two classes that receive different proportions of the interest and
principal distributions from a pool of mortgage assets. A Fund will only invest
in SMBS whose mortgage assets are U.S. Government obligations.
A common type of SMBS will be structured so that one class receives some
of the interest and most of the principal from the mortgage assets, while the
other class receives most of the interest and the remainder of the principal. If
the underlying mortgage assets experience greater than anticipated prepayments
of principal, a Fund may fail to fully recoup its initial investment in these
securities. The market value of any class which consists primarily or entirely
of principal payments generally is unusually volatile in response to changes in
interest rates.
The average life of mortgage-backed securities varies with the maturities
of the underlying mortgage instruments. The average life is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities as the result of mortgage prepayments, mortgage refinancings, or
foreclosures. The rate of mortgage prepayments, and hence the average life of
the certificates, will be a function of the level of interest rates, general
economic conditions, the location and age of the mortgage and other social and
demographic conditions. Such prepayments are passed through to the registered
holder with the regular monthly payments of principal and interest and have the
effect of reducing future payments. Estimated average life will be determined by
the Adviser and used for the purpose of determining the average weighted
maturity and duration of the Funds.
Non-Mortgage Asset-backed Securities. Non-mortgage asset-backed securities
include interests in pools of receivables, such as motor vehicle installment
purchase obligations and credit card receivables. Such securities are generally
issued as pass-through certificates, which represent undivided fractional
ownership interests in the underlying pools of assets. Such securities also may
be debt instruments, which are also known as collateralized obligations and are
generally issued as the debt of a special purpose entity organized solely for
the purpose of owning such assets and issuing such debt. Such securities also
may include instruments issued by certain trusts, partnerships or other special
purpose issuers, including pass-through certificates representing participations
in, or debt instruments backed by, the securities and other assets owned by such
issuers.
Non-mortgage-backed securities are not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities.
The purchase of non-mortgage-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
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servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the asset-backed securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the larger number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the obligations
underlying the asset-backed securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the asset-backed securities. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on those securities. In addition, various state and Federal laws give
the motor vehicle owner the right to assert against the holder of the owner's
obligation certain defenses such owner would have against the seller of the
motor vehicle. The assertion of such defenses could reduce payments on the
related asset- backed securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and Federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike most
other asset-backed securities, credit card receivables are unsecured obligations
of the card holder.
The development of non-mortgage-backed securities is at an early stage
compared to mortgage-backed securities. While the market for asset-backed
securities is becoming increasingly liquid, the market for mortgage-backed
securities issued by certain private organizations and non- mortgage-backed
securities is not as well developed. As stated above, the Adviser, intends to
limit its purchases of mortgage-backed securities issued by certain private
organizations and non- mortgage-backed securities to securities that are readily
marketable at the time of purchase.
Special Situations
As described in the Prospectuses, certain Funds may invest in "special
situations." A special situation arises when, in the opinion of the Adviser, the
securities of a particular company will, within a reasonably estimable period of
time, be accorded market recognition at an appreciated value solely by reason of
a development applicable to that company, and regardless of general business
conditions or movements of the market as a whole. Developments creating special
situations might include, among others: liquidations, reorganizations,
recapitalizations, mergers, material litigation, technical breakthroughs and new
management or management policies. Although large and well known companies may
be involved, special situations more often involve comparatively small or
unseasoned companies. Investments in unseasoned companies and special situations
often involve much greater risk than is inherent in ordinary investment
securities.
Equity Swap Contracts
The counterparty to an Equity Swap Contract will typically be a bank,
investment banking firm or broker/dealer. For example, the counterparty will
generally agree to pay a Fund the amount, if any, by which the notional amount
of the Equity Swap Contract would have increased in value had it been invested
in the stocks comprising the S&P 500 Index in proportion to the composition of
the Index, plus the dividends that would have been received on those stocks. A
Fund will agree to pay to the counterparty a floating rate of interest
(typically the London Inter Bank Offered Rate) on the notional amount of the
Equity Swap Contract plus the amount, if any,
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by which that notional amount would have decreased in value had it been invested
in such stocks. Therefore, the return to a Fund on any Equity Swap Contract
should be the gain or loss on the notional amount plus dividends on the stocks
comprising the S&P 500 Index less the interest paid by the Fund on the notional
amount. A Fund will only enter into Equity Swap Contracts on a net basis, i.e.,
the two parties' obligations are netted out, with the Fund paying or receiving,
as the case may be, only the net amount of any payments. Payments under the
Equity Swap Contracts may be made at the conclusion of the contract or
periodically during its term.
If there is a default by the counterparty to an Equity Swap Contract, a
Fund will be limited to contractual remedies pursuant to the agreements related
to the transaction. There is no assurance that Equity Swap Contract
counterparties will be able to meet their obligations pursuant to Equity Swap
Contracts or that, in the event of default, a Fund will succeed in pursuing
contractual remedies. A Fund thus assumes the risk that it may be delayed in or
prevented from obtaining payments owed to it pursuant to Equity Swap Contracts.
A Fund will closely monitor the credit of Equity Swap Contract counterparties in
order to minimize this risk.
Each Fund may from time to time enter into the opposite side of Equity
Swap Contracts (i.e., where a Fund is obligated to pay the increase (net of
interest) or receive the decrease (plus interest) on the contract to reduce the
amount of the Fund's equity market exposure consistent with the Fund's
objective. These positions are sometimes referred to as Reverse Equity Swap
Contracts.
Equity Swap Contracts will not be used to leverage a Fund. A Fund will
not enter into any Equity Swap Contract or Reverse Equity Swap Contract unless,
at the time of entering into such transaction, the unsecured senior debt of the
counterparty is rated at least A by Moody's or S&P. Since the SEC considers
Equity Swap Contracts and Reverse Equity Swap Contracts to be illiquid
securities, a Fund will not invest in Equity Swap Contracts or Reverse Equity
Swap Contracts if the total value of such investments together with that of all
other illiquid securities which a Fund owns would exceed 15% of the Fund's total
assets.
The Adviser does not believe that a Fund's obligations under Equity
Swap Contracts or Reverse Equity Swap Contracts are senior securities and,
accordingly, the Fund will not treat them as being subject to its borrowing
restrictions. However, the net amount of the excess, if any, of a Fund's
obligations over its respective entitlements with respect to each Equity Swap
Contract and each Reverse Equity Swap Contract will be accrued on a daily basis
and an amount of cash, U.S. Government securities or other liquid high quality
debt securities having an aggregate market value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian.
Reverse Repurchase Agreements
At the time a Fund enters into a reverse repurchase agreement, it may
establish a segregated account with its custodian bank in which it will maintain
cash, U.S. Government Securities or other liquid high grade debt obligations
equal in value to its obligations in respect of reverse repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the
securities the Funds are obligated to repurchase under the agreement may decline
below the repurchase price. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Funds' use
of proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to
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enforce the Funds' obligation to repurchase the securities. Reverse repurchase
agreements are speculative techniques involving leverage, and are subject to
asset coverage requirements if the Funds do not establish and maintain a
segregated account (as described above). In addition, some or all of the
proceeds received by a Fund from the sale of a portfolio instrument may be
applied to the purchase of a repurchase agreement. To the extent the proceeds
are used in this fashion and a common broker/dealer is the counterparty on both
the reverse repurchase agreement and the repurchase agreement, the arrangement
might be recharacterized as a swap transaction. Under the requirements of the
1940 Act, the Funds are required to maintain an asset coverage (including the
proceeds of the borrowings) of at least 300% of all borrowings. Depending on
market conditions, the Funds' asset coverage and other factors at the time of a
reverse repurchase, the Funds may not establish a segregated account when the
Adviser believes it is not in the best interests of the Funds to do so. In this
case, such reverse repurchase agreements will be considered borrowings subject
to the asset coverage described above.
Securities Lending
To increase return on portfolio securities, certain of the Funds may
lend their portfolio securities to broker/dealers and other institutional
investors pursuant to agreements requiring that the loans be continuously
secured by collateral equal at all times in value to at least the market value
of the securities loaned. Collateral for such loans may include cash, securities
of the U.S. Government, its agencies or instrumentalities, an irrevocable letter
of credit issued by (i) a U.S. bank that has total assets exceeding $1 billion
and that is a member of the Federal Deposit Insurance Corporation, or (ii) a
foreign bank that is one of the 75 largest foreign commercial banks in terms of
total assets, or any combination thereof. Such loans will not be made if, as a
result, the aggregate of all outstanding loans of the Fund involved exceeds 30%
of the value of its total assets. There may be risks of delay in receiving
additional collateral or in recovering the securities loaned or even a loss of
rights in the collateral should the borrower of the securities fail financially.
However, loans are made only to borrowers deemed by the Adviser to be of good
standing and when, in its judgment, the income to be earned from the loan
justifies the attendant risks. A Fund that is engaged in lending its portfolio
securities has the right to call each loan, and obtain the return of securities
identical to the transferred securities upon such termination of the loan, upon
notice of not more than five business days and thereby secure the return to the
Fund of securities identical to the transferred securities upon termination of
the loan.
Short Sales
As described in the Prospectuses, certain Funds may from time to time
enter into short sales transactions. A Fund will not make short sales of
securities nor maintain a short position unless at all times when a short
position is open, such Fund owns an equal amount of such securities or
securities convertible into or exchangeable, without payment of any further
consideration, for securities of the same issue as, and equal in amount to, the
securities sold short. This is a technique known as selling short "against the
box." Such short sales will be used by a Fund for the purpose of deferring
recognition of gain or loss for federal income tax purposes.
Guaranteed Investment Contracts
Guaranteed Investment Contracts, investment contracts or funding agreements
(each referred to as a "GIC") are investment instruments issued by highly rated
insurance companies. Pursuant to such contracts, a Fund may make cash
contributions to a deposit fund of the insurance company's
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general or separate accounts. The insurance company then credits to a Fund
guaranteed interest. The insurance company may assess periodic charges against a
GIC for expense and service costs allocable to it, and the charges will be
deducted from the value of the deposit fund. The purchase price paid for a GIC
generally becomes part of the general assets of the issuer, and the contract is
paid from the general assets of the issuer.
A Fund will only purchase GICs from issuers which, at the time of purchase,
meet quality and credit standards established by the Adviser. Generally, GICs
are not assignable or transferable without the permission of the issuing
insurance companies, and an active secondary market in GICs does not currently
exist. Also, a Fund may not receive the principal amount of a GIC from the
insurance company on seven days' notice or less, at which point the GIC may be
considered to be an illiquid investment.
Illiquid Securities
The Funds may invest up to 15% of their net assets in securities that are
considered illiquid because of the absence of a readily available market or due
to legal or contractual restrictions. Certain restricted securities that are not
registered for sale to the general public but that can be resold to
institutional investors may not be considered illiquid, provided that a dealer
or institutional trading market exists.
Commercial Instruments
Commercial Instruments consist of short-term U.S. dollar-denominated
obligations issued by domestic corporations or issued in the U.S. by foreign
corporations and foreign commercial banks.
Investments by a Fund in commercial paper will consist of issues rated
in a manner consistent with such Fund's investment policies and objective. In
addition, the Funds may acquire unrated commercial paper and corporate bonds
that are determined by the Adviser at the time of purchase to be of comparable
quality to rated instruments that may be acquired by the Funds as previously
described.
Variable-rate master demand notes are unsecured instruments that permit
the indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate. Variable-rate instruments acquired by a Fund will be rated at a
level consistent with such Fund's investment objective and policies of high
quality as determined by a major rating agency or, if not rated, will be of
comparable quality as determined by the Adviser.
Variable- and floating-rate instruments are unsecured instruments that
permit the indebtedness thereunder to vary. While there may be no active
secondary market with respect to a particular variable- or floating-rate
instrument purchased by a Fund, a Fund may, from time to time as specified in
the instrument, demand payment of the principal or may resell the instrument to
a third party. The absence of an active secondary market, however, could make it
difficult for a Fund to dispose of an instrument if the issuer defaulted on its
payment obligation or during periods when a Fund is not entitled to exercise its
demand rights, and a Fund could, for these or other reasons, suffer a loss. A
Fund may invest in variable- and floating-rate instruments only when the
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Adviser deems the investment to involve minimal credit risk. A Fund may invest
in variable and floating rate instruments only when the adviser deems the
investment to involve minimal credit risk. If such instruments are not rated,
the Adviser will consider the earning power, cash flows, and other liquidity
ratios of the issuers of such instruments and will continuously monitor their
financial status to meet payment on demand. In determining average weighted
portfolio maturity, an instrument will be deemed to have a maturity equal to the
longer of the period remaining to the next interest rate adjustment or the
demand notice period specified in the instrument.
Municipal Securities
The two principal classifications of municipal securities are "general
obligation" securities and "revenue" securities. General obligation securities
are secured by the issuer's pledge of its full faith, credit, and taxing power
for the payment of principal and interest. Revenue securities are payable only
from the revenues derived from a particular facility or class of facilities or,
in some cases, from the proceeds of a special excise tax or other specific
revenue source such as the user of the facility being financed. Private activity
bonds held by a Fund are in most cases revenue securities and are not payable
from the unrestricted revenues of the issuer. Consequently, the credit quality
of private activity bonds is usually directly related to the credit standing of
the corporate user of the facility involved.
Municipal securities may include "moral obligation" bonds, which are
normally issued by special purpose public authorities. If the issuer of moral
obligation bonds is unable to meet its debt service obligations from current
revenues, it may draw on a reserve fund, the restoration of which is a moral
commitment but not a legal obligation of the state or municipality which created
the issuer.
Municipal securities may include variable- or floating-rate instruments
issued by industrial development authorities and other governmental entities.
While there may not be an active secondary market with respect to a particular
instrument purchased by a Fund, a Fund may demand payment of the principal and
accrued interest on the instrument or may resell it to a third party as
specified in the instrument. The absence of an active secondary market, however,
could make it difficult for a Fund to dispose of the instrument if the issuer
defaulted on its payment obligation or during periods the Fund is not entitled
to exercise its demand rights, and the Fund could, for these or other reasons,
suffer a loss.
Some of these instruments may be unrated, but unrated instruments
purchased by a Fund will be determined by the Adviser to be of comparable
quality at the time of purchase to instruments rated "high quality" by any major
rating service. Where necessary to ensure that an instrument is of comparable
"high quality," a Fund will require that an issuer's obligation to pay the
principal of the note may be backed by an unconditional bank letter or line of
credit, guarantee, or commitment to lend.
Municipal Securities may include participations in privately arranged
loans to municipal borrowers, some of which may be referred to as "municipal
leases." Generally such loans are unrated, in which case they will be determined
by the Adviser to be of comparable quality at the time of purchase to rated
instruments that may be acquired by a Fund. Frequently, privately arranged loans
have variable interest rates and may be backed by a bank letter of credit. In
other cases, they may be unsecured or may be secured by assets not easily
liquidated. Moreover, such loans in most cases are not backed by the taxing
authority of the issuers and may have limited
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marketability or may be marketable only by virtue of a provision requiring
repayment following demand by the lender. Such loans made by a Fund may have a
demand provision permitting the Fund to require payment within seven days.
Participations in such loans, however, may not have such a demand provision and
may not be otherwise marketable. To the extent these securities are illiquid,
they will be subject to each Fund's limitation on investments in illiquid
securities. Recovery of an investment in any such loan that is illiquid and
payable on demand may depend on the ability of the municipal borrower to meet an
obligation for full repayment of principal and payment of accrued interest
within the demand period, normally seven days or less (unless a Fund determines
that a particular loan issue, unlike most such loans, has a readily available
market). As it deems appropriate, the Adviser will establish procedures to
monitor the credit standing of each such municipal borrower, including its
ability to meet contractual payment obligations.
Municipal Securities may include units of participation in trusts
holding pools of tax-exempt leases. Municipal participation interests may be
purchased from financial institutions, and give the purchaser an undivided
interest in one or more underlying municipal security. To the extent that
municipal participation interests are considered to be "illiquid securities,"
such instruments are subject to each Fund's limitation on the purchase of
illiquid securities. Municipal leases and participating interests therein which
may take the form of a lease or an installment sales contract, are issued by
state and local governments and authorities to acquire a wide variety of
equipment and facilities. Interest payments on qualifying leases are exempt from
Federal income tax.
In addition, certain of the Funds may acquire "stand-by commitments"
from banks or broker/dealers with respect to Municipal Securities held in their
portfolios. Under a stand-by commitment, a dealer would agree to purchase at a
Fund's option specified Municipal Securities at a specified price. A Fund will
acquire stand-by commitments solely to facilitate portfolio liquidity and do not
intend to exercise their rights thereunder for trading purposes.
Although the Funds do not presently intend to do so on a regular basis,
each may invest more than 25% of its total assets in Municipal Securities the
interest on which is paid solely from revenues of similar projects if such
investment is deemed necessary or appropriate by the Adviser. To the extent that
more than 25% of a Fund's total assets are invested in Municipal Securities that
are payable from the revenues of similar projects, a Fund will be subject to the
peculiar risks presented by such projects to a greater extent than it would be
if its assets were not so concentrated.
Real Estate Investment Trusts
A real estate investment trust ("REIT") is a managed portfolio of real
estate investments which may include office buildings, apartment complexes,
hotels and shopping malls. An Equity REIT holds equity positions in real estate,
and it seeks to provide its shareholders with income from the leasing of its
properties, and with capital gains from any sales of properties. A Mortgage REIT
specializes in lending money to developers of properties, and passes any
interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying
property owned or financed by the REIT, while Mortgage REITs also may be
affected by the quality of credit extended. Both Equity and Mortgage REITs are
dependent upon management skill and may not be diversified. REITs also may be
subject to heavy cash flow dependency, defaults by borrowers,
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self-liquidation, and the possibility of failing to qualify for tax-free
pass-through of income under the Internal Revenue Code of 1986, as amended (the
"Code").
Additional Investment Limitations
The most significant investment restrictions applicable to the Funds'
investment programs are set forth in the Prospectuses under the heading "How
Objectives Are Pursued-Investment Limitations" Additionally, as a matter of
fundamental policy which may not be changed without a majority vote of a Fund's
shareholders (as that term is defined under the heading "Investment Advisory,
Administration, Custody, Transfer Agency, Shareholder Servicing, Shareholder
Administration and Distribution Agreements -- The Company and Its Common Stock"
in this SAI).
each Fund will not:
1. Borrow money or issue senior securities as defined in the 1940 Act except
that (a) a Fund may borrow money from banks for temporary or emergency
purposes in amounts up to one-third of the value of such Fund's total
assets at the time of borrowing, provided that borrowings in excess of 5%
of the value of such Fund's total assets will be repaid prior to the
purchase of additional portfolio securities by such Fund, (b) a Fund may
enter into commitments to purchase securities in accordance with the
Fund's investment program, including delayed delivery and when-issued
securities, which commitments may be considered the issuance of senior
securities, and (c) a Fund may issue multiple classes of shares in
accordance with SEC regulations or exemptions under the 1940 Act. The
purchase or sale of futures contracts and related options shall not be
considered to involve the borrowing of money or issuance of senior
securities.
2. Purchase any securities on margin (except for such short-term credits
as are necessary for the clearance of purchases and sales of portfolio
securities) or sell any securities short (except against the box.) For
purposes of this restriction, the deposit or payment by the Fund of
initial or maintenance margin connection with futures contracts and
related options and options on securities is not considered to be the
purchase of a security on margin.
3. Underwrite securities issued by any other person, except to the extent
that the purchase of securities and the later disposition of such
securities in accordance with the Fund's investment program may
be deemed an underwriting. This restriction shall not limit a Fund's
ability to invest in securities issued be other registered investment
companies.
4. Invest in real estate or real estate limited partnership interests. (The
Fund may, however, purchase and sell securities secured by real
estate or interests therein or issued by issuers which invest in real
estate or interests therein.) This restriction does not apply to real
estate limited partnerships listed on a national stock exchange (e.g., the
New York Stock Exchange).
5. Purchase or sell commodity contracts except that each Fund may, to the
extent appropriate under its investment policies, purchase publicly traded
securities of companies engaging in whole or in part in such activities,
may enter into futures contracts and related options, may engage in
transactions on a when-issued or forward commitment basis, and may enter
into forward currency contracts in accordance with its investment policies.
In addition, certain non-fundamental investment restrictions are also
applicable to various investment portfolios, including the following:
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<PAGE>
1. No Fund of the Company will purchase or retain the securities of any issuer
if the officers, or directors of the Company, its advisers, or managers
owning beneficially more than one half of one percent of the securities of
each issuer together own beneficially more than five percent of such
securities.
2. No Fund of the Company will purchase securities of unseasoned issuers,
including their predecessors, that have been in operation for less than
three years, if by reason thereof the value of such Fund's investment in
such classes of securities would exceed 5% of such Fund's total assets. For
purposes of this limitation, issuers include predecessors, sponsors,
controlling persons, general partners, guarantors and originators of
underlying assets which have less than three years of continuous operation
or relevant business experience.
3. No Fund will purchase puts, calls, straddles, spreads and any combination
thereof if by reason thereof the value of its aggregate investment in such
classes of securities will exceed 5% of its total assets except that: (a)
this restriction shall not apply to standby commitments, (b) this
restriction shall not apply to a Fund's transactions in futures contracts
and related options, and (c) a Fund may obtain short-term credit as may be
necessary for the clearance of purchases and sales of portfolio securities.
4. No Fund will invest in warrants, valued at the lower of cost or market, in
excess of 5% of the value of such Fund's assets, and no more than 2% of the
value of the Fund's net assets may be invested in warrants that are not
listed on principal domestic or foreign exchanges (for purposes of this
undertaking, warrants acquired by a Fund in units or attached to securities
will be deemed to have no value).
5. No Fund of the Company will purchase securities of companies for the
purpose of exercising control.
6. No Fund of the Company will invest more than 15% of the value of its
net assets in illiquid securities, including repurchase agreements,
time deposits and GICs with maturities in excess of seven days,
illiquid restricted securities, and other securities which are not
readily marketable. For purposes of this restriction, illiquid securities
shall not include securities which may be resold under Rule 144A and
Section 4(2) of the Securities Act of 1933 that the Board of Directors,
or its delegate, determines to be liquid, based upon the trading markets
for the specific security.
7. No Fund of the Company will mortgage, pledge or hypothecate any assets
except to secure permitted borrowings and then only in an amount up to
one-third of the value of the Fund's total assets at the time of
borrowing. For purposes of this limitation, collateral arrangements with
respect to the writing of options, futures contracts, options on futures
contracts, and collateral arrangements with respect to initial and
variation margin are not considered to be a mortgage, pledge or
hypothecation of assets.
8. No Fund of the Company will invest in securities of other
investment companies, except as they may be acquired as part of
a merger, consolidation or acquisition of assets and except to the extent
otherwise permitted by the 1940 Act.
28
<PAGE>
9. No Fund of the Company will purchase oil, gas or mineral leases or other
interests (a Fund may, however, purchase and sell the securities of
companies engaged in the exploration, development, production, refining,
transporting and marketing of oil, gas or minerals).
NET ASSET VALUE
Purchases and Redemptions
See "How To Buy Shares" and "How To Redeem Shares" in the Prospectuses
for a complete description of the manner in which Shares of the various classes
of the Funds may be purchased and redeemed.
The Funds also are available for a variety of retirement plans,
including IRAs, that allow investors to shelter some of their income from taxes.
Investors should contact their Selling Agents for details concerning retirement
plans.
The right of redemption may be suspended or the date of payment
postponed when (a) trading on the New York Stock Exchange is restricted, as
determined by applicable rules and regulations of the SEC, (b) the New York
Stock Exchange is closed for other than customary weekend and holiday closings,
(c) the SEC has by order permitted such suspension, or (d) an emergency as
determined by the SEC exists making disposal of portfolio securities or the
valuation of the net assets of a Fund of the Company not reasonably practicable.
Net Asset Value Determination
Shares of the common stock of each class of shares of each Fund that
are offered by the Prospectuses are sold at their respective net asset value
next determined after the receipt of the purchase order, plus any applicable
sales charge. Shareholders may at any time redeem all or a portion of their
shares at net asset value next determined following receipt of a redemption
order, less any contingent deferred sales charge applicable to Investor Shares.
The net asset value per share of each of the Funds is determined at the
times and in the manner described in the Prospectuses.
A security of a Fund listed or traded on an exchange is valued at its
last sales price on the exchange where the security is principally traded or,
lacking any sales on a particular day, the security is valued at the mean
between the closing bid and asked prices on that day. Each security traded in
the over-the-counter market (but not including securities reported on the NASDAQ
National Market System) is valued at the mean between the last bid and asked
prices based upon quotes furnished by market makers for such securities. Each
security reported on the NASDAQ National Market System is valued at the last
sales price on the valuation date. Securities may be valued on the basis of
prices provided by an independent pricing service. Prices provided by the
pricing service may be determined without exclusive reliance on quoted prices,
and may reflect appropriate factors such as yield, type of issue, coupon rate
maturity and seasoning differential. Securities for which prices are not
provided by the pricing service are valued at the mean between the last bid and
asked prices based upon quotes furnished by market makers for such securities.
Securities of a Fund for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
supervision of the Company's officers in a
29
<PAGE>
manner specifically authorized by the Board of Directors of the Company.
Short-term obligations having 60 days or less to maturity are valued at
amortized cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of such securities used in computing the net asset value of
the shares of a Fund are determined as of such times. Foreign currency exchange
rates are also generally determined prior to the close of the New York Stock
Exchange. Occasionally, events affecting the value of such securities and such
exchange rates may occur between the times at which they are determined and the
close of the New York Stock Exchange, which will not be reflected in the
computation of net asset value. If during such periods events occur which
materially affect the value of such securities, the securities will be valued at
their fair market value as determined in good faith by the directors.
For purposes of determining the net asset value per share of a Fund,
all assets and liabilities of such Fund initially expressed in foreign
currencies will be converted into U.S. dollars at the mean between the bid and
offer prices of such currencies against U.S. dollars quoted by a major bank that
is a regular participant in the foreign exchange market or on the basis of a
pricing service that takes into account the quotes provided by a number of such
major banks.
Exchanges
By use of the exchange privilege, the holder of Investor Shares and/or
Primary Shares authorizes the transfer agent or the shareholder's financial
institution to rely on telephonic instructions from any person representing
himself to be the investor and reasonably believed to be genuine. The transfer
agent's or a financial institution's records of such instructions are binding.
Exchanges are taxable transactions for Federal income tax purposes; therefore, a
shareholder will realize a capital gain or loss depending on whether the
Investor Shares and/or Primary Shares being exchanged have a value which is more
or less than their adjusted cost basis.
The Company may limit the number of times the exchange privilege may be
exercised by a shareholder within a specified period of time. Also, the exchange
privilege may be terminated or revised at any time by the Company upon such
notice as may be required by applicable regulatory agencies (presently sixty
days for termination or material revision), provided that the exchange privilege
may be terminated or materially revised without notice under certain unusual
circumstances.
The Prospectuses for the Investor Shares and Primary Shares of each
Fund describe the exchange privileges available to holders of such Investor
Shares and Primary Shares, respectively.
DESCRIPTION OF SHARES
Dividends and Distributions
For purposes of the corporate alternative minimum tax (the "AMT") and
the environmental superfund tax the corporate dividends received deduction is
not itself an item of tax preference that must be added back to taxable income
or is otherwise disallowed in determining a corporation's alternative minimum
taxable income ("AMTI"). However, corporate shareholders will generally be
required to take the full amount of any dividend received from the Emerging
30
<PAGE>
Markets Fund or the Pacific Growth Fund into account (without a
dividends-received deduction) in determining its adjusted current earnings. The
Funds may purchase the securities of certain foreign investment funds or trusts
called passive foreign investment companies ("PFICs"). If a Fund invests in a
PFIC, it may be subject to U.S. federal income tax and certain interest charges
on a portion of any "excess distribution" from this investment and any gain
arising from the disposition thereof, irrespective of whether the Fund
distributes all of its investment company taxable income and net capital gain to
its shareholders. Gains on the sale of PFIC holdings will be deemed to be
ordinary income regardless of how long such PFICs are held. However, the Fund
may elect to treat any PFIC in which it invests as a "qualified electing fund."
If the Fund makes this election, it would, in lieu of the foregoing, include in
its income its share of the PFIC's ordinary income and net capital gain, even if
such included amounts are not distributed to the Fund. Accordingly, such amounts
would be subject to the 90% and excise tax distribution requirements described
above. Each Fund intends to make a qualified electing fund election for every
PFIC in which it invests.
Distributions by a Fund that do not constitute ordinary income
dividends, exempt-interest dividends or capital gain dividends will be treated
as a return of capital to the extent of (and in reduction of) the shareholder's
tax basis in his/her shares; any excess will be treated as gain from the sale of
his/her shares, as discussed below.
Prior to purchasing shares in one of the Funds, the impact of dividends
or distributions which are expected to be or have been declared, but not paid,
should be carefully considered. Any dividend or distribution declared shortly
after a purchase of such shares prior to the record date will have the effect of
reducing the per share net asset value by the per share amount of the dividend
or distribution. All or a portion of such dividend or distribution, although in
effect a return of capital, may be subject to tax.
Distributions by a Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of such Fund (or of another Fund). Shareholders receiving a
distribution in the form of additional shares will be treated as receiving a
distribution in an amount equal to the fair market value of the shares received,
determined as of the reinvestment date. In addition, if the net asset value at
the time a shareholder purchases shares of a Fund reflects undistributed net
investment income or recognized capital gain net income, or unrealized
appreciation in the value of the assets of the Fund, distributions of such
amounts will be taxable to the shareholder in the manner described above,
although such distributions economically constitute a return of capital to the
shareholder.
Emerging Markets Fund and Pacific Growth Fund
Dividends and distributions from net investment income, if any, are
declared and paid quarterly, and capital gains distributions are declared and
paid annually. The Investor A, Investor C, Investor N and Primary B Shares of
the Funds shall accrue an additional expense not borne by the Primary A Shares
as a result of the applicable Rule 12b-1 Plan, Shareholder Servicing Plan and/or
Shareholder Administration Plan. Consequently, a separate calculation shall be
made to arrive at the net asset value per share and dividends of each class of
shares of the Funds.
Global Government Income Fund
Dividends and distributions from net investment income are declared
daily and paid monthly, and capital gains distributions are declared and paid
annually. The Investor A,
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<PAGE>
Investor C, Investor N and Primary B Shares of the Fund shall accrue an
additional expense not borne by the Primary A Shares as a result of the 12b-1
Plans, Shareholder Servicing Plan and Shareholder Administration Plan.
Consequently, a separate calculation shall be made to arrive at the net asset
value per share and dividends of each class of shares of the Fund.
Net investment income for the Funds for dividend purposes consists of
(i) interest accrued and original issue discount earned on a Fund's assets, (ii)
plus the amortization of market discount and minus the amortization of market
premium on such assets, (iii) less accrued expenses directly attributable to the
Fund and the general expenses of the Company prorated to a Fund on the basis of
its relative net assets, plus dividend or distribution income on a Fund's
assets.
ADDITIONAL INFORMATION CONCERNING TAXES
The following is only a summary of certain additional tax
considerations generally affecting the Funds and their shareholders that are not
described in the Prospectuses. No attempt is made to present a detailed
explanation of the tax treatment of each Fund or its shareholders, and the
discussion here and in the Prospectuses is not intended as a substitute for
careful tax planning.
The Company has received a private letter ruling from the Internal
Revenue Service to the effect that the differing fees imposed on Primary A,
Primary B, Investor A, Investor C and Investor N Shares with respect to
servicing, distribution and administrative support services, and transfer agency
arrangements, and the differing sales charges on purchases and redemptions of
such shares, does not result in the Company's dividends or distributions
constituting "preferential dividends" under the Code.
Qualification as a Regulated Investment Company
Each Fund expects to qualify as a regulated investment company under
Subchapter M of the Code. As a regulated investment company, each Fund is not
subject to federal income tax on the portion of its net investment income (i.e.,
taxable interest, dividends and other taxable ordinary income, net of expenses)
and capital gain net income (i.e., the excess of capital gains over capital
losses) that it distributes to shareholders, provided that it distributes at
least 90% of its investment company taxable income (i.e., net investment income
and the excess of its net short-term capital gain over net long-term capital
loss) and at least 90% of its tax-exempt income (net of expenses allocable
thereto) for the taxable year (the "Distribution Requirement"), and satisfies
certain other requirements of the Code some of which are described below.
Distributions by a Fund made during the taxable year or, under specified
circumstances, within twelve months after the close of the taxable year, will be
considered distributions of income and gains of the taxable year and can
therefore satisfy the Distribution Requirement.
In addition to satisfying the Distribution Requirement, a regulated
investment company must (i) derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign currencies
(to the extent such currency gains are directly related to the regulated
investment company's principal business of investing in stock or securities) and
other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "Income Requirement"); and (ii) derive less
than 30% of its gross income (exclusive of certain gains on designated hedging
transactions that are offset by realized or unrealized losses on offsetting
positions) from the sale or other disposition
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<PAGE>
of stock, securities or foreign currencies (or options, futures or forward
contracts thereon) held for less than three months ("Short-Short Gains").
However, foreign currency gains, including those derived from options, futures
and forwards, will not be characterized as Short-Short Gain if they are directly
related to the regulated investment company's principal business of investing in
stock or securities (or options or futures thereon). Because of the limitations
on Short-Short Gains, a Fund may have to limit the sale of appreciated
securities that it has held for less than three months. However, these
limitations will not prevent a Fund from disposing of specific investments at a
loss, since the recognition of a loss before the expiration of the three-month
holding period is disregarded for purposes of Short-Short Gains. Interest
(including original issue discount) received by a Fund at maturity or upon the
disposition of a security held for less than three months will not be treated as
gross income derived from the sale or other disposition of such security for
purposes of Short-Short Gains. However, income that is attributable to realized
market appreciation will be treated as gross income from the sale or other
disposition of securities for this purpose.
In general, gain or loss recognized by a Fund on the disposition of an
asset will be a capital gain or loss. However, gain recognized on the
disposition of a debt obligation (including tax-exempt obligations purchased
after April 30, 1993) purchased by a Fund at a market discount (generally, at a
price less than its principal amount) will be treated as ordinary income to the
extent of the portion of the market discount which accrued during the period of
time the Fund held the debt obligation. In addition, under the of Section 988 of
the Code, gain or loss recognized on the disposition of a debt obligation
denominated in a foreign currency or an option with respect thereto (but only to
the extent attributable to changes in foreign currency exchange rates), and gain
or loss recognized on the disposition of a foreign currency forward contract,
futures contract, option or similar financial instrument, or of foreign currency
itself, will generally be treated as ordinary income or loss.
In general, for purposes of determining whether capital gain or loss
recognized by a Fund on the disposition of an asset is long-term or short-term,
the holding period of the asset may be affected if (i) the asset is used to
close a "short sale" (which includes for certain purposes the acquisition of a
put option) or is substantially identical to another asset so used, (ii) the
asset is otherwise held by the Fund as part of a "straddle" (which term
generally excludes a situation where the asset is stock and the Fund grants a
qualified covered call option (which, among other things, must not be
deep-in-the-money) with respect thereto) or (iii) the asset is stock and the
Fund grants an in-the-money qualified covered call option with respect thereto.
However, for purposes of Short-Short Gains, the holding period of the asset
disposed of may be reduced only in the case of clause (i) above. In addition, a
Fund may be required to defer the recognition of a loss on the disposition of an
asset held as part of a straddle may be deferred to the extent of any
unrecognized gain on the offsetting position.
Any gain recognized by a Fund on the lapse of, or any gain or loss
recognized by a Fund from a closing transaction with respect to, an option
written by the Fund will be treated as a short-term capital gain or loss. For
purposes of the Short-Short Gains, the holding period of an option written by a
Fund will commence on the date it is written and end on the date it lapses or
the date a closing transaction is entered into. Accordingly, a Fund may be
limited in its ability to write options which expire within three months and to
enter into closing transactions at a gain within three months of the writing of
options.
Transactions that may be engaged in by certain of the Funds (such as
futures contracts and options on stock indices and futures contracts) will be
subject to special tax treatment as "Section
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1256 contracts." Section 1256 contracts are treated as if they are sold for
their fair market value on the last business day of the taxable year, regardless
of whether a taxpayer's obligations (or rights) under such contracts have
terminated (by delivery, exercise, entering into a closing transaction or
otherwise) as of such date. Any gain or loss arising from the actual or deemed
disposition of a Section 1256 contract is treated as 60% long-term capital gain
or loss and 40% short-term capital gain or loss. The Internal Revenue Service
has held in several private rulings that gains arising from Section 1256
contracts will not be treated as Short-Short Gains if the gains arise from a
deemed disposition. A Fund may elect not to have this special tax treatment
apply to Section 1256 contracts that are part of "mixed straddles" with other
investments of the Fund that are not Section 1256 contracts.
A regulated investment company, in determining its net capital gain
(i.e., the excess of net long-term capital gain over net short-term capital
loss) for any taxable year, must generally treat all or part of or net capital
loss, or net long-term capital loss incurred after October 31 as if they had
been incurred in the succeeding year. Treasury regulations similarly provide
that a regulated investment company can elect to defer until the next taxable
year recognition of its net capital loss and net currency loss, to the extent
such losses arise after October 31 of the current taxable year, in determining
its investment company taxable income.
In addition to satisfying the requirement described above, each Fund
must satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of each Fund's
taxable year, at least 50% of the value of the Fund's assets must consist of
cash and cash items, U.S. Government securities, securities of other regulated
investment companies, and securities of other issuers (as to which the Fund has
not invested more than 5% of the value of the Fund's total assets in securities
of such issuer and as to which the Fund does not hold more than 10% of the
outstanding voting securities of such issuer), and no more than 25% of the value
of its total assets may be invested in the securities of any one issuer (other
than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses or related trades or
businesses.
If for any taxable year a Fund does not qualify as a regulated
investment company, all of its taxable income (including its net capital gain)
will be subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable as
ordinary dividends to the extent of such Fund's current and accumulated earnings
and profits.
Excise Tax on Regulated Investment Companies
A nondeductible 4% excise tax will be imposed on each Fund (other than
to the extent of the Fund's tax-exempt income) to the extent it does not meet
certain minimum distribution requirements by the end of each calendar year. Each
Fund will either actually or be deemed to distribute substantially all of its
net investment income and net capital gains by the end of each calendar year
and, thus, expects not to be subject to the excise tax.
Sale or Redemption of Shares
A shareholder will recognize gain or loss on the sale or redemption of
shares of a Fund in an amount equal to the difference between the proceeds of
the sale or redemption and the shareholder's adjusted tax basis in the shares.
All or a portion of any loss so recognized may be
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<PAGE>
disallowed if the shareholder purchases other shares of the Fund (or
substantially identical shares) within 30 days before or after the sale or
redemption. In general, any gain or loss arising from (or treated as arising
from) the sale or redemption of shares of a Fund will be considered capital in
nature and will be long-term capital gain or loss if the shares were held for
longer than one year. However, any capital loss arising from the sale or
redemption of shares held for six months or less will be disallowed to the
extent of the amount of exempt-interest dividends received on such shares and
(to the extent not disallowed) will be treated as a long-term capital loss to
the extent of the amount of capital gain dividends received on such shares.
Capital losses in any year are deductible only to the extent of capital gains
plus, in the case of a taxpayer filing on an individual tax return, $3,000 of
ordinary income.
If a shareholder (i) incurs a sales load in acquiring shares of a Fund,
(ii) disposes of such shares less than 91 days after they are acquired and (iii)
subsequently acquires shares of the Fund or another fund at a reduced sales load
pursuant to a right to reinvest at such reduced sales load acquired in
connection with the acquisition of the shares disposed of, then the sales load
on the shares disposed of (to the extent of the reduction in the sales load on
the shares subsequently acquired) shall not be taken into account in determining
gain or loss on the shares disposed of, but shall be treated as incurred on the
acquisition of the shares subsequently acquired.
The Company may make payment for redemptions in readily marketable
securities or other property if it is appropriate to do so in light of the
company's responsibilities under the 1940 Act. Such payments in-kind shall also
result in recognized gain or loss, and most likely be capital in nature, to a
redeeming shareholder on the difference between the fair market value of the
securities received and the shareholder's adjusted tax basis if the Fund shares
are redeemed.
As of the printing of this SAI, the maximum individual tax rate
applicable to ordinary income is 39.6% (marginal rates may be higher for some
individuals due to phase out of exemptions and elimination of deductions); the
maximum individual tax rate applicable to net capital gains is 28%; and the
maximum corporate tax rate applicable to ordinary income and net capital gains
is 35% (however, to eliminate the benefit of lower marginal corporate income tax
rates, corporations which have taxable income in excess of $100,000 for a
taxable year will be required to pay an additional amount of income tax of up to
$11,750 and corporations which have taxable income in excess of $15,000,000 for
a taxable year will be required to pay an additional amount of tax of up to
$100,000).
Foreign Shareholders
Taxation of a shareholder who, as to the United States, is a
nonresident alien individual, foreign trust or estate, foreign corporation, or
foreign partnership ("foreign shareholder"), depends on whether the income from
a Fund is "effectively connected" with a U.S. trade or business carried on by
such shareholder.
If the income from a Fund is not effectively connected with a U.S.
trade or business carried on by a foreign shareholder, ordinary income dividends
will be subject to U.S. withholding tax at the rate of 30% (or lower applicable
treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign
shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower
applicable treaty rate) on the gross income resulting from the Fund's election
to treat any foreign taxes paid by its shareholders, but may not be allowed a
deduction against this gross income or a credit against this U.S. withholding
tax for the foreign shareholder's pro rata share of
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<PAGE>
such foreign taxes which it is treated as having paid. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized on the sale of shares of a Fund, capital gain dividends and
exempt-interest dividends and amounts retained by a Fund that are designated as
undistributed capital gains.
If the income from a Fund is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income dividends,
capital gain dividends and any gains realized upon the sale of shares of the
Fund will be subject to U.S. federal income tax at the rates applicable to U.S.
citizens, U.S. residents, or domestic corporations.
In the case of foreign non-corporate shareholders, a Fund may be
required to withhold U.S. federal income tax at a rate of 31% on distributions
that are otherwise exempt from withholding tax (or taxable at a reduced treaty
rate) unless such shareholders furnish the Fund with proper notification of
their foreign status.
The tax consequences to a foreign shareholder entitled to claim the
benefits of an applicable tax treaty may be different from those described
herein. Foreign shareholders are urged to consult their own tax advisors with
respect to the particular tax consequences to them of an investment in a Fund,
including the applicability of foreign taxes.
Effect of Future Legislation; Local Tax Considerations
The foregoing general discussion of U.S. federal income tax
consequences is based on the Code and the regulations issued thereunder as in
effect on the date of this Statement of Additional Information. Future
legislative or administrative changes or court decisions may significantly
change the conclusions expressed herein, and any such changes or decisions may
have a retroactive effect with respect to the transactions contemplated herein.
Rules of state and local taxation for ordinary income dividends,
exempt-interest dividends and capital gain dividends from regulated investment
companies often differ from the rules for U.S. federal income taxation described
above. Distributions of net investment income may be taxable to shareholders as
dividend income under state or local law even though a substantial portion of
such distributions may be derived from interest on U.S. Government obligations,
which, if realized directly, would be exempt from such taxes. Shareholders are
urged to consult their tax advisors as to the consequences of these and other
state and local tax rules affecting investment in the Funds.
DIRECTORS AND OFFICERS
The directors and executive officers of the Company and their principal
occupations during the last five years are set forth below. The address of each,
unless otherwise indicated, is 111 Center Street, Little Rock, Arkansas 72201.
Those Directors who are "interested persons" of the Company (as defined in the
1940 Act) are indicated by an asterisk (*).
<TABLE>
<CAPTION>
Principal Occupations
During Past 5 Years
Position with and Current
Name, Address, and Age the Company Directorships
<S> <C> <C>
Edmund L. Benson, III, 59 Director Director, President and Treasurer,
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<PAGE>
Saunders & Benson, Inc. Saunders & Benson, Inc. (Insurance);
728 East Main Street Trustee, Nations Institutional Reserves
Suite 400 and Nations Fund Trust; Director,
Richmond, VA 23219 Nations Fund, Inc. and Nations Fund
Portfolios, Inc.
James Ermer, 53 Director Senior Vice President- Finance, CSX
13705 Hickory Nut Point Corporation (transportation and natural
Midlothian, VA 23112 resources); Director, National Mine
Service; Director, Lawyers Title
Corporation; Trustee, Nations
Institutional Reserves and Nations Fund
Trust; Director, Nations Fund, Inc. and
Nations Fund Portfolios, Inc.
William H. Grigg, 63 Director Since April 1994, Chairman and Chief
Duke Power Co. Executive Officer; November 1991 to
422 South Church Street April 1994, Vice Chairman, Duke
PB04G Power Co.; from April 1988 to
Charlotte, NC 28242-0001 November 1991, Executive Vice
President Customer Group, Duke
Power Co.; Director, Hatteras
Income Securities, Inc., Nations
Government Income Term Trust
2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc.
and Nations Fund Portfolios,
Inc.; Trustee, Nations
Institutional Reserves and
Nations Fund Trust.
Thomas F. Keller, 64 Director R.J. Reynolds Industries Professor of
Fuqua School of Business Business Administration and Dean,
P.O. Box 90120 Fuqua School of Business, Duke
Duke University University; Director, LADD Furniture,
Durham, NC 27708 Inc.; Director, Wendy's International
Mentor Growth Fund, and Cambridge
Trust; Director, Hatteras Income
Securities, Inc., Nations
Government Income Term Trust
2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc.
and Nations Fund Portfolios,
Inc.; Trustee, Nations
Institutional Reserves and
Nations Fund Trust.
Carl E. Mundy, Jr., 61 Director Commandant, United States Marine
37
<PAGE>
9308 Ludgate Drive Corps, from July 1991 to July
Alexandria, VA 22309 1995; Commanding General, Marine
Forces Atlantic, from June 1990
to June 1991; Director, Nations
Fund, Inc. and Nations Fund
Portfolios, Inc.; Trustee,
Nations Institutional Reserves
and Nations Fund Trust.
A. Max Walker, 74* President, Director and Financial consultant; Formerly,
4580 Windsor Gate Court Chairman of the Board President, A. Max Walker, Inc.;
Atlanta, GA 30342 Director and Chairman of the Board,
Hatteras Income Securities, Inc.,
Nations Government Income Term
Trust 2003, Inc., Nations
Government Income Term Trust
2004, Inc., Nations Balanced
Target Maturity Fund, Inc.,
Nations Fund, Inc. and Nations
Fund Portfolios, Inc.; President
and Chairman of the Board of
Trustees, Nations Institutional
Reserves and Nations Fund Trust.
Charles B. Walker, 57 Director Since 1989, Director, Executive Vice
Ethyl Corporation President, Chief Financial Officer and
330 South Fourth Street Treasurer, Ethyl Corporation
Richmond, VA 23219 (chemicals, plastics, and aluminum
manufacturing); since 1994, Vice
Chairman, Ethyl Corporation and Vice
Chairman, Chief Financial Officer and
Treasurer, Albemarle Corporation,
Director, Nations Fund, Inc. and
Nations Fund Portfolios, Inc.; Trustee,
Nations Institutional Reserves and
Nations Fund Trust.
Thomas S. Word, Jr., 58* Director Partner, McGuire Woods Battle &
McGuire, Woods, Battle Boothe (law); Director, Vaughan Bassett
& Boothe Furniture Company, Director VB
One James Center Williams Furniture Company, Inc.;
Richmond, VA 23219 Director, Nations Fund, Inc. and
Nations Fund Portfolios, Inc.; Trustee,
Nations Institutional Reserves and
Nations Fund Trust.
38
<PAGE>
Richard H. Blank, Jr., 39 Secretary Since 1994, Vice President of Mutual
Stephens Inc. Fund Services, Stephens Inc. 1990 to
1994, Manager Mutual Fund Services,
Stephens Inc. 1983 to 1990, Associate in
Corporate Finance Department,
Stephens Inc.; Secretary, Nations
Institutional Reserves, Nations Fund
Trust, Nations Fund, Inc. and Nations
Fund Portfolios, Inc.
Michael W. Nolte, 35 Assistant Secretary Associate, Financial Services
Stephens Inc. Group of Stephens Inc.
Louise P. Newcomb, 43 Assistant Secretary Corporate Syndicate
Stephens Inc. Associate, Stephens Inc.
James E. Banks, 40 Assistant Secretary Since 1993, Attorney,
Stephens Inc. Stephens Inc.; Associate
Corporate Counsel, Federated
Investors; from 1991 to 1993,
Staff Attorney, Securities and
Exchange Commission from 1988 to
1991
Richard H. Rose, 40 Treasurer Since 1994, Vice President, Division
First Data Investor Services Manager, First Data Investor Services
Group, Inc. Group, Inc., since 1988, Senior Vice
One Exchange Place President, The Boston Company
Boston, MA 02109 Advisors, Inc.; Treasurer, Nations
Institutional Reserves, Nations Fund
Trust, Nations Fund, Inc. and Nations
Fund Portfolios, Inc.
Joseph C. Viselli, 32 Assistant Treasurer Since 1994, Director, First Data
First Data Investor Services Investor Services Group, Inc., since
Group, Inc. 1992, Assistant Vice President, The
One Exchange Place Boston Company Advisors, Inc., since
Boston, MA 02109 1989, Senior Accountant, Price
Waterhouse LLP
Susan Manter, 42 Assistant Treasurer Since 1996, Vice President, First Data
First Data Investor Services Investor Services Group, Inc., since
Group, Inc. 1994, Vice President, Scudder Stevens
One Exchange Place and Clark, Inc., previously Senior
Boston, MA 02109 Manager, Coopers & Lybrand LLP
</TABLE>
39
<PAGE>
Mr. Rose serves as Treasurer to certain other investment companies
for which First Data Investors Services Group, Inc. or its affiliates serve as
sponsor, distributor, administrator and/or investment adviser. Mr. Blank
serves as Secretary and Treasurer, Chief Operating Officer to other investment
companies for which Stephens Inc. serves as administrator.
Each Director of the Company is also a Director of Nations Fund, Inc.
and a Trustee of Nations Fund Trust and Nations Institutional Reserves, each a
registered investment company that is part of the Nations Fund Family.
Richard H. Blank, Jr., Richard H. Rose, Joseph C. Viselli, Susan Manter,
Michael W. Nolte, Louise P. Newcomb and James E. Banks, Jr. are also officers
of Nations Fund. Inc., Nations Fund Trust and Nations Institutional Reserves.
As of the date of this SAI, the directors and officers of the Company
as a group owned less than 1% of the outstanding shares of each of the Funds.
The Company has adopted a Code of Ethics which, among other things,
prohibits each access person of the Company from purchasing or selling
securities when such person knows or should have known that, at the time of the
transaction, the security (i) was being considered for purchase or sale by a
Fund, or (ii) was being purchased or sold by a Fund. For purposes of the Code of
Ethics, an access person means (i) a Director or officer of the Company, (ii)
any employee of the Company (or any company in a control relationship with the
Company) who, in the course of his/her regular duties, obtains information
about, or makes recommendations with respect to, the purchase or sale of
securities by the Company, and (iii) any natural person in a control
relationship with the Company who obtains information concerning recommendations
made to the Company regarding the purchase or sale of securities. Portfolio
managers and other persons who assist in the investment process are subject to
additional restrictions, including a requirement that they disgorge to the
Company any profits realized on short-term trading (i.e., the purchase/sale or
sale/purchase of securities within any 60-day period). The above restrictions do
not apply to purchases or sales of certain types of securities, including mutual
fund shares, money market instruments and certain U.S. Government securities. To
facilitate enforcement, the Code of Ethics generally requires that the Company's
access persons, other than its "disinterested" Directors, submit reports to the
Company's designated compliance person regarding transactions involving
securities which are eligible for purchase by a Fund.
Nations Funds Retirement Plan
Under the terms of the Nations Funds Retirement Plan for Eligible
Directors (the "Retirement Plan"), each director may be entitled to certain
benefits upon retirement from the Board of Directors. Pursuant to the Retirement
Plan, the normal retirement date is the date on which the eligible director has
attained age 65 and has completed at least five years of continuous service with
one or more of the open-end investment companies ("Funds") advised by the
Adviser. If a director retires before reaching age 65, no benefits are payable.
Each eligible director is entitled to receive an annual benefit from the Funds
commencing on the first day of the calendar quarter coincident with or next
following his date of retirement equal to 5% of the aggregate director's fees
payable by the Funds during the calendar year in which the director's retirement
occurs multiplied by the number of years of service (not in excess of ten years
of service) completed with respect to any of the Funds. Such benefit is payable
to each eligible director in quarterly installments for a period of no more than
five years. If an eligible director dies after attaining age 65, the director's
surviving spouse (if any) will be entitled to receive 50% of the
40
<PAGE>
benefits that would have been paid (or would have continued to have been paid)
to the director if he had not died. The Retirement Plan is unfunded. The
benefits owed to each director are unsecured and subject to the general
creditors of the Funds.
Nations Funds Deferred Compensation Plan
Under the terms of the Nations Funds Deferred Compensation Plan for
Eligible Directors (the "Deferred Compensation Plan"), each director may elect,
on an annual basis, to defer all or any portion of the annual board fees
(including the annual retainer and all attendance fees) payable to the director
for that calendar year. An application was submitted to and approved by the SEC
to permit deferring directors to elect to tie the rate of return on fees
deferred pursuant to the Deferred Compensation Plan to one or more of certain
investment portfolios of certain Funds. Distributions from the deferring
directors' deferral accounts will be paid in cash, in generally equal quarterly
installments over a period of five years beginning on the date the deferring
director's retirement benefits commence under the Retirement Plan. The Board of
Directors, in its sole discretion, may accelerate or extend such payments after
a director's termination of service. If a deferring director dies prior to the
commencement of the distribution of amounts in his deferral account, the balance
of the deferral account will be distributed to his designated beneficiary in a
lump sum as soon as
practicable after the director's death. If a deferring director dies after the
commencement of such distribution, but prior to the complete distribution of his
deferral account, the balance of the amounts credited to his deferral account
will be distributed to his designated beneficiary over the remaining period
during which such amounts were distributable to the director. Amounts payable
under the Deferred Compensation Plan are not funded or secured in any way and
deferring directors have the status of unsecured creditors of the Funds from
which they are deferring compensation.
<TABLE>
<CAPTION>
COMPENSATION TABLE
Aggregate Estimated
Compensation Pension or Retirement Annual Total Compensation
Name of Person from Benefits Accrued as Benefits Upon from Registrant and
- -
Position (1) Registrant (2) Part of Fund Expenses Retirement Fund Complex(3)(4)
------------ --------------- --------------------- ---------- ------------------
<S> <C> <C>
Edmund L. Benson, III, $6,899 $19,488 $21,000 $49,119
Trustee
James Ermer 5,375 19,488 21,000 44,250
Trustee
William H. Grigg 5,922 19,488 21,000 66,397
Trustee
Thomas F. Keller 6,924 19,488 21,000 68,597
Trustee
A. Max Walker 8,375 19,488 25,000 75,250
41
<PAGE>
Chairman of the Board
Charles B. Walker 6,875 19,488 21,000 43,750
Trustee
Thomas S. Word 6,924 19,488 21,000 51,579
Trustee
Carl E. Mundy, Jr. 5,250 0 21,000 25,875
Trustee
(1) All directors receive reimbursements for expenses related to their attendance at meetings of the Board of
Directors. Officers of the Company receive no direct remuneration in such capacity from the Company.
(2) For the twelve-month period ended March 31, 1996. Each Director receives (i) an annual retainer of
1,000 ( 3,000 for the Chairman of the Board) plus 500 for each Fund of the Company, plus (ii) a fee
of 1,000 for attendance at each "in-person" meeting of the Board of Directors (or committee thereof)
and 500 for attendance at each other meeting of the Board of Directors (or Committee thereof).
(3) Messrs. Grigg, Keller and A.M. Walker receive compensation from eight investment companies,
including the Company, that are deemed to be part of the Nations Fund "fund complex," as that term is
defined under Rule 14a-101 of the Securities Exchange Act of 1934, as amended. Messrs. Benson, Ermer, C.
Walker, Mundy and Word receive compensation from four investment companies, including the
Company, deemed to be part of the Nations Fund fund complex.
(4) Total compensation amounts include deferred compensation (including interest) payable to or accrued for
the following Directors: Edmund L. Benson, III ( 25,744); William H. Grigg ( 47,897); Thomas F.
Keller ( 51,596); and Thomas S. Word ( 54,579).
</TABLE>
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY, SHAREHOLDER SERVICING AND
DISTRIBUTION AGREEMENTS
The Company and Its Common Stock
The Company is an open-end diversified management investment company
organized as a corporation under the laws of the State of Maryland on January
23, 1995. The Company offers shares of common stock which represent interests in
one of three separate Funds. This SAI relates to the following Funds of the
Company: the Emerging Markets Fund, the Pacific Growth Fund and the Global
Government Income Fund. Each Fund offers the following separate classes of
shares: Primary A Shares, Primary B Shares, Investor A Shares, Investor C Shares
and Investor N Shares. Shares of each Fund of the Company are redeemable at the
net asset value (less any applicable contingent deferred sales charge ("CDSC")
thereof at the option of the holders thereof or in certain circumstances at the
option of the Company. For information concerning the methods of redemption and
the rights of share ownership, consult the Prospectuses under the captions "How
To Buy Shares," "How To Redeem Shares" and "Organization And History."
As used in this SAI and in the Prospectuses, the term "majority of the
outstanding shares" of the Company, a particular Fund or a particular class of
shares of a Fund means, respectively, the vote of the lesser of (i) 67% or more
of the shares of the Company, Fund or class (as
42
<PAGE>
appropriate) present at a meeting of shareholders, if the holders of more than
50% of the outstanding shares entitled to vote, are present or represented by
proxy, or (ii) more than 50% of the outstanding shares of the Company, Fund or
class.
The Board of Directors may classify or reclassify any unissued shares of the
Company into shares of any class, classes or Fund in addition to those already
authorized by setting or changing in any one or more respects, from time to
time, prior to the issuance of such shares, the preferences, conversion or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications, or terms or conditions of redemption, of such shares and,
pursuant to such classification or reclassification to increase or decrease the
number of authorized shares of any Fund or class. Any such classification or
reclassification will comply with the provisions of the 1940 Act. Fractional
shares shall have the same rights as full shares to the extent of their
proportionate interest.
Investment Adviser
Effective January 1, 1996, the Adviser began serving as investment
adviser to the Funds, pursuant to an Investment Advisory Agreement dated January
1, 1996. The Adviser is a wholly owned subsidiary of NationsBank, N.A.
("NationsBank"), which in turn is a wholly owned banking subsidiary of
NationsBank Corporation, a bank holding company organized as a North Carolina
corporation.
The Adviser also serves as investment adviser to Nations Fund, Inc.,
Nations Fund Trust and The Capitol Mutual Funds, each a registered investment
company that is part of the Nations Fund family of funds. In addition, the
Adviser serves as the investment adviser to Hatteras Income Securities. Inc.,
Nations Government Income Term Trust 2003, Inc., Nations Government Income Term
Trust 2004, Inc. and Nations Balanced Target Maturity Fund, Inc., each a
closed-end diversified management investment company traded on the New York
Stock Exchange.
Prior to January 1, 1996, NationsBank, through its Investment
Management Division, served as investment adviser to the Funds. NationsBank is a
wholly owned subsidiary of NationsBank Corporation, a bank holding company
organized as a North Carolina corporation. NationsBank and NationsBank
Corporation are located at One NationsBank Plaza, Charlotte, North Carolina
28255.
Since 1874, NationsBank and its predecessors have been managing money
for foundations, universities, corporations, institutions and individuals.
Today, NationsBank and its affiliates manage over 50 billion, including over 18
billion in Nations Fund assets. It is a company dedicated to a goal of providing
responsible investment management and superior service. NationsBank is
recognized for its sound investment approaches, which place it among the
nation's foremost financial institutions. NationsBank and its affiliated
organizations make available a wide range of financial services to its over 6
million customers through over 1700 banking and investment centers.
Approximately 12 of NationsBank's personnel are involved in stock and bond
research.
NationsBank restructured its investment management division as of
January 1, 1996 by reorganizing the division into two separate, wholly owned
advisory subsidiaries, the Adviser and TradeStreet Investment Associates, Inc.
The restructuring resulted in the transfer of the division's investment
management and advisory functions to the Adviser. The investment professionals
who performed investment company management functions as employees of
NationsBank continue to
43
<PAGE>
perform such services as employees of the Adviser. The restructuring did not
change the scope and nature of investment advisory services provided to the
Funds.
Gartmore is a joint venture structured as a Delaware general
partnership between NB Partner Corp., a wholly owned subsidiary of NationsBank
and Gartmore U.S. Limited, an indirect wholly owned subsidiary of Gartmore
Investment Management plc ("Gartmore plc"), a publicly listed U.K. company.
National Westminster Bank plc and affiliated parties (collectively, "NatWest)
own 100% of the equity of Gartmore plc. Gartmore is a registered investment
adviser in the United States and a member of the Investment Management
Regulatory Organization Limited, a U.K. regulatory authority. The respective
principal offices of NBAI, TradeStreet and Gartmore are located at One
NationsBank Plaza, Charlotte, N.C. 28255.
Prior to April 10, 1996, the predecessor to Gartmore, Nations Gartmore
Investment Management ("Nations Gartmore"), provided sub-advisory services to
NBAI and the Funds. Nations Gartmore was a joint venture structured as a general
partnership between NB Partner Corp. and Gartmore U.S.Limited. On April 10,
1996, NatWest purchased control of Gartmore plc from Compagnie de Suez, S.A. and
affiliated entities (collectively, "Compagnie de Suez") through a two-part
transaction involving (1) the direct purchase from Compagnie de Suez of its
indirect subsidiary Indosuez UK Asset Management Limited, which held 75% of the
outstanding voting shares of Gartmore plc; and (2) the acquisition of the
remaining portion of Gartmore plc's shares held by public shareholders through a
tender offer. This acquisition resulted in the change of control of Nations
Gartmore and the creation of a successor entity, Gartmore. On July 17, 1996, the
shareholders of the Funds approved the new sub-advisory arrangements with
Gartmore. There were no material changes to the personnel who provided service
to the Funds, and the change in ownership did not result in a change in the
level of service provided the Funds or the level of sub- advisory fees.
Pursuant to the terms of the Advisory and Sub-Advisory Agreements
relating to the Funds Investment, the Adviser and Gartmore (the "Sub-Adviser"),
subject at all times to the control of the Company's Board of Directors and in
conformance with the stated policies of the Company, select and manage the
investments of the Funds. The Adviser obtains and evaluates economic,
statistical and financial information to formulate and implement investment
policies for the Funds. The Investment Advisory Agreement provides that in the
absence of willful misfeasance, bad faith, negligence or reckless disregard of
obligations or duties thereunder on the part of the Adviser, or any of its
officers, directors, employees or agents, the Adviser shall not be subject to
liability to the Company or to any shareholder of the Company for any act or
omission in the course of, or connected with, rendering services thereunder or
for any losses that may be sustained in the purchase, holding or sale of any
security. The Sub-Advisory Agreement provides that the Sub- Adviser shall not be
liable to the Company or to its shareholders for any act or omission by the
Adviser or the Sub-Adviser or for any loss sustained by the Company or by its
shareholders except in the case of the Adviser or the Sub-Adviser's willful
misfeasance, bad faith, gross negligence or reckless disregard of duty on the
part of NBAI or the Sub-Adviser, as the case may be.
The Investment Advisory Agreement was approved by the Company's Board of
Directors at the October 12-13 Meeting of the Board of Directors. The Investment
Advisory Agreement shall become effective with respect to a Fund if and when
approved by the Directors of the Company, and if so approved, shall thereafter
continue from year to year, provided that such continuation of the Agreement is
specifically approved at least annually by (a) (i) the Company's Board of
44
<PAGE>
Directors or (ii) the vote of "a majority of the outstanding voting securities"
of a Fund (as defined in Section 2(a)(42) of the 1940 Act), and (b) the
affirmative vote of a majority of the Company's Directors who are not parties to
such Agreement or "interested persons" (as defined in the 1940 Act) of a party
to such Agreement (other than as Directors of the Company), by votes cast in
person at a meeting specifically called for such purpose. The Investment
Advisory Agreement will terminate automatically in the event of its assignment,
and is terminable with respect to a Fund at any time without penalty by the
Company (by vote of the Board of Directors or by vote of a majority of the
outstanding voting securities of the Fund) or by NBAI on 60 days' written
notice.
The Sub-Advisory Agreement was approved by the Company's Board of
Directors on January 26, 1995 and by the initial shareholder on June 30, 1995.
The Sub-Advisory Agreement will continue in effect for an initial term of two
years from its effective date and continues in effect from year to year
thereafter only if such continuance is specifically approved at least annually
by the Company's Board of Directors and the affirmative vote of a majority of
the directors who are not parties to the Sub-Advisory Agreement or "interested
persons" of any such party by votes cast in person at a meeting called for such
purpose. The respective Funds, NBAI or Gartmore may terminate the Sub-Advisory
Agreement, on 60 days' written notice without penalty. The Advisory Agreement
terminates automatically in the event of its "assignment," as defined in the
1940 Act.
The advisory fee for the Emerging Markets Fund is calculated daily and
paid monthly at the annual rate of 1.10% of the Fund's average daily net assets.
NBAI pays the Sub-Adviser a fee determined at the annual rate of 0.85% of the
Fund's average daily net assets. The advisory fee for the Pacific Growth Fund is
calculated daily and paid monthly at the annual rate of 0.90% of the Fund's
average daily net assets. NBAI pays the Sub-Adviser a fee determined at the
annual rate of 0.70% of the Fund's average daily net assets. The Global
Government Income Fund pays NBAI an advisory fee determined at the annual rate
of 0.70% of the Fund's average daily net assets. NBAI pays the Sub-Adviser a fee
determined at the annual rate of 0.54% of the Fund's average daily net assets.
NBAI may waive a portion of their fees; however, any such waiver may be
discontinued at any time. As discussed under the caption "Expenses," the Adviser
will be required to reduce their fees from the Funds, in direct proportion to
the fees payable by the Funds to the Adviser, the Sub- Adviser, the
Administrator and the Co-Administrator, if the expenses of the Funds exceed the
applicable expense limitation of any state in which the Funds' shares are
registered or qualified for sale.
The table below states the advisory fees paid to Nations Bank and/or
its wholly-owned affiliate NBAI and the advisory fees waived for the fiscal
period from June 1, 1995 to March 31, 1996.
ADVISORY FEES
Period Ended March 31, 1996
Net Advisory
Advisory Fees
Fees Waived
Nations Pacific Growth Fund $ 307,806.00 $ 0.00
Nations Emerging Markets Fund 188,334.00 0.00
Nations Global Government Fund 1132,152.00 0.00
45
<PAGE>
The table below states the sub-advisory fees paid to NBAI and the
sub-advisory fees waived for the fiscal period from June 1, 1995 to March 31,
1996.
SUB-ADVISORY FEES
Period Ended March 31, 1996
Net Sub-Advisory
Sub-Advisory Fees Fees Waived
Nations Pacific Growth Fund $ 145,531.05 $ 0.00
Nations Emerging Markets Fund 239,405.20 0.00
Nations Global Government Fund 101,945.98 0.00
Investment Styles
When you invest in any Fund in the Nations Fund Family, you can be
assured your money is managed according to a disciplined investment style; one
that remains constant regardless of particular styles coming in and out of
favor. The Adviser believes this structured approach to managing portfolio
securities may provide you with consistent performance over time. These
investment styles consist of the Emerging Markets and Pacific Growth Funds
Style and the Global Government Income Fund Style. These styles are described
below.
Emerging Markets and Pacific Growth Funds Style
The Emerging Markets and Pacific Growth Funds utilize an investment
philosophy that emphasizes investment in reasonably priced growth stocks. This
philosophy assumes that superior earnings growth will lead to greater investment
returns. In the case of global or international portfolios this philosophy
concentrates on stock selection and asset allocation aimed at strategically
overweighting growing markets while avoiding those with less possibility of
appreciation. This investment approach is designed to add value while also
providing diversification to minimize risk.
Gartmore selects stocks for its portfolios using rigorous stock
selection criteria. Their analysis is designed to discover securities which
demonstrate a potential for above market earnings growth rates while maintaining
reasonable valuation levels and whose parent corporations show strong balance
sheets and quality management. In order to ascertain these facts, Gartmore
representatives make on site inspections of the companies under review, as well
as their competitors, suppliers and customers.
The allocation of assets is determined by portfolio managers based on
both qualitative and quantitative research. This research includes the
identification of investment themes, political and economic trends,
price/earnings ratios, real interest rates and earnings growth projections.
These factors determine economic, market, interest rate and currency forecasts
which are, in turn, used to determine regional allocations.
Utilizing the investment strategy set forth above, Nations Emerging
Markets Fund invests in securities of companies located in emerging market
countries. These countries include, but are
46
<PAGE>
not limited to: Argentina, Brazil, Chile, China, Czech Republic, Colombia,
Ecuador, Greece, Hong Kong, Indonesia, India, Malaysia, Mexico, The Philippines,
Poland, Portugal, Peru, Russia, Singapore, South Africa, Thailand, Taiwan,
Turkey.
Global Government Income Fund Style
The Global Government Income Fund bases its investment decisions on an
analysis of longer term economic trends which are believed to be key to
successful fixed income investing. This tendency to take into account long term
economic trends is coupled with the practice of investing primarily in
investment grade government securities which minimize the investor's credit
risk.
This investment policy is effected by carefully analyzing interest rate
forecasts and currency movements for various markets and using this information
to determine regional allocations. These allocations are then adjusted to
reflect the portfolio manager's perception of the most favorable markets and
issuers. Fundamental economic strength, credit quality and interest rate trends
are the principal factors considered by the portfolio's management in
determining whether to increase or decrease the emphasis placed on a particular
country or type of security.
Administrator and Co-Administrator
The Company has retained Stephens Inc. ("Administrator") as the
administrator and First Data Investors Services Group, Inc. (the
"Co-Administrator") as the co-administrator of the Company.
The Administrator and Co-Administrator serve under an administration
agreement ("Administration Agreement") and co-administration agreement
("Co-Administration Agreement"), respectively, each of which was approved by the
Board of Directors on January 25, 1995. The Administrator receives, as
compensation for its services rendered under the Administration Agreement and as
agent for the Co-Administrator for the services it provides under the Co-
Administration Agreement, an administrative fee, computed daily and paid
monthly, at the annual rate of 0.10% of the average daily net assets of each
Fund.
Pursuant to the Administration Agreement, the Administrator has agreed
to, among other things, (i) maintain office facilities for the Funds, (ii)
furnish statistical and research data, data processing, clerical, and internal
executive and administrative services to the Company, (iii) furnish corporate
secretarial services to the Company, including coordinating the preparation and
distribution of materials for Board of Directors meetings, (iv) coordinate the
provision of legal advice to the Company with respect to regulatory matters, (v)
coordinate the preparation of reports to the Company's shareholders and the SEC,
including annual and semi-annual reports, (vi) coordinate the provision of
services to the Company by the Co-Administrator, the Transfer Agents and the
Custodian, and (vii) generally assist in all aspects of the Company's
operations. Additionally, the Administrator is authorized to receive, as agent
for the Co-Administrator, the fees payable to the Co-Administrator by the
Company for its services rendered under the Co- Administration Agreement. The
Administrator bears all expenses incurred in connection with the performance of
its services.
Pursuant to the Co-Administration Agreement, the Co-Administrator has
agreed to, among other things, (i) provide accounting and bookkeeping services
for the Funds, (ii) compute each
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<PAGE>
Fund's net asset value and net income, (iii) accumulate information required for
the Company's reports to shareholders and the SEC, (iv) prepare and file the
Company's Federal and state tax returns, (v) perform monthly compliance testing
for the Company, and (vi) prepare and furnish the Company monthly broker
security transaction summaries and transaction listings and performance
information. The Co-Administrator bears all expenses incurred in connection with
the performance of its services.
The Administration Agreement and the Co-Administration Agreement may be
terminated by a vote of a majority of the Board of Directors, or by the
Administrator or Co-Administrator, respectively, on 60 days' written notice
without penalty. The Administration Agreement and Co- Administration Agreement
are not assignable without the written consent of the non-assigning party.
Furthermore, the Administration Agreement and the Co-Administration Agreement
provide that the Administrator and Co-Administrator, respectively, shall not be
liable to the Funds or to their shareholders except in the case of the
Administrator's or Co-Administrator's respective willful misfeasance, bad faith,
gross negligence or reckless disregard of duty.
As discussed under the caption "Expenses," the Administrator and
Co-Administrator will be required to reduce their fee from the Company, in
direct proportion to the fees payable to the Administrator and Co-Administrator
by the Company, if the expenses of the Company exceed the applicable expense
limitation of any state in which the Funds' shares are registered or qualified
for sale.
The table set forth below states the net Administration fees paid and
waived for the fiscal period from June 1, 1995 to March 31, 1996.
ADMINISTRATION FEES
Period Ended March 31, 1996
Net Administration
Admin. Fees
Fees Waived
Nations Pacific Growth Fund $ 34,201.00 $ 0.00
Nations Emerging Markets Fund 17,121.00 0.00
Nations Global Government Fund 18,879.00 0.00
Distributor
Stephens Inc. (the "Distributor") serves as the principal underwriter
and distributor of the shares of the Funds.
At a meeting held on January 25, 1995, the Board of Directors selected
Stephens Inc. as Distributor, and approved a distribution agreement
("Distribution Agreement") with the Distributor. Pursuant to the Distribution
Agreement, the Distributor, as agent, sells shares of the Funds on a continuous
basis and transmits purchase and redemption orders that its receives to the
Company or the Transfer Agent (as defined under the caption "Transfer Agents and
Custodian"). Additionally, the Distributor has agreed to use appropriate efforts
to solicit orders for the sale of
48
<PAGE>
shares and to undertake such advertising and promotion as it believes
appropriate in connection with such solicitation. Pursuant to the Distribution
Agreement, the Distributor, at its own expense, finances those activities which
are primarily intended to result in the sale of shares of the Funds, including,
but not limited to, advertising, compensation of underwriters, dealers and sales
personnel, the printing of prospectuses to other than existing shareholders, and
the printing and mailing of sales literature. The Distributor, however, may be
reimbursed for all or a portion of such expenses to the extent permitted by a
distribution plan adopted by the Company pursuant to Rule 12b-1 under the 1940
Act.
The Distribution Agreement will continue year to year as long as such
continuance is approved at least annually by (i) the Board of Directors or a
vote of the majority (as defined in the 1940 Act) of the outstanding voting
securities of a Fund and (ii) a majority of the directors who are not parties to
the Distribution Agreement or "interested persons" of any such party by a vote
cast in person at a meeting called for such purpose. The Distribution Agreement
is not assignable and is terminable with respect to a Fund, without penalty, on
60 days' notice by the Board of Directors, the vote of a majority (as defined in
the 1940 Act) of the outstanding voting securities of such Fund, or by the
Distributor.
Distribution Plans and Shareholder Servicing Arrangements for Investor Shares
Investor A Shares
The Company has adopted a Shareholder Servicing and Distribution Plan
(the "Investor A Plan") pursuant to Rule 12b-1 under the 1940 Act with respect
to each Fund's Investor A Shares. The Investor A Plan provides that each Fund
may pay the Distributor or banks, broker/dealers or other financial institutions
that offer shares of the Fund and that have entered into a Sales Support
Agreement with the Distributor ("Selling Agents") or a Shareholder Servicing
Agreement with the Company ("Servicing Agents"), up to 0.25% (on an annualized
basis) of the average daily net asset value of such Fund.
Payments under the Investor A Plan may be made to the Distributor for
reimbursements of distribution-related expenses actually incurred by the
Distributor, including, but not limited to, expenses of organizing and
conducting sales seminars, printing of prospectuses and statements of additional
information (and supplements thereto) and reports for other than existing
shareholders, preparation and distribution of advertising material and sales
literature and costs of administering the Investor A Plan, or to Servicing
Agents that have entered into a Shareholder Servicing Agreement with the Company
for providing shareholder support services to their customers ("Customers")
which hold of record or beneficially Investor A Shares of a Fund. Such
shareholder support services provided by Servicing Agents to holders of Investor
A Shares of the Funds may include (i) aggregating and processing purchase and
redemption requests for Investor A Shares from their Customers and transmitting
promptly net purchase and redemption orders to the Company's distributor or
transfer agent; (ii) providing their Customers with a service that invests the
assets of their accounts in Investor A Shares pursuant to specific or
pre-authorized instructions; (iii) processing dividend and distribution payments
from the Company on behalf of their Customers; (iv) providing information
periodically to their Customers showing their positions in Investor A Shares;
(v) arranging for bank wires; (vi) responding to their Customers' inquiries
concerning their investment in Investor A Shares; (vii) providing subaccounting
with respect to Investor A Shares beneficially owned by their Customers or the
information necessary for subaccounting; (viii) if required by law, forwarding
shareholder communications from the
49
<PAGE>
Company (such as proxies, shareholder reports, annual and semi-annual financial
statements and dividend, distribution and tax notices) to their Customers; (ix)
forwarding to their Customers proxy statements and proxies containing any
proposals regarding the Shareholder Servicing Agreement; (x) providing general
shareholder liaison services; and (xi) providing such other similar services as
the Company may reasonably request to the extent the Selling Agent is permitted
to do so under applicable statutes, rules or regulations.
Expenses incurred by the Distributor pursuant to the Investor A Plan in
any given year may exceed the sum of the fees received under the Investor A
Plan. Any such excess may be recovered by the Distributor in future years so
long as the Investor A Plan is in effect. If the Investor A Plan were terminated
or not continued, a Fund would not be contractually obligated to pay the
Distributor for any expenses not previously reimbursed by the Fund.
During the fiscal period ended March 31, 1996 the Distributor received
$7,579 from 12b-1 fees and $1,533 from front end sales load fees in connection
with Investor A Shares. Of this amount, the Distributor retained $0 of the 12b-1
fees and $224.17 of the front end sales load fees and paid the balance to
selling dealers.
Investor C Shares
The Directors of the Company have approved a Distribution Plan in
accordance with Rule 12b-1 under the 1940 Act for the Investor C Shares of the
Funds (the "Investor C Plan"). Pursuant to the Investor C Plan, each Fund may
pay the Distributor for certain expenses that are incurred in connection with
the distribution of shares. Payments under the Investor C Plan will be
calculated daily and paid monthly at a rate set from time to time by the Board
of Directors provided that the annual rate may not exceed 0.75% of the average
daily net asset value of Investor C Shares of a Fund. Payments to the
Distributor pursuant to the Investor C Plan will be used (i) to compensate
Selling Agents for providing sales support assistance relating to Investor C
Shares, (ii) for promotional activities intended to result in the sale of
Investor C Shares such as to pay for the preparation, printing and distribution
of prospectuses to other than current shareholders, and (iii) to compensate
Selling Agents for providing sales support services with respect to their
Customers who are, from time to time, beneficial and record holders of Investor
C Shares. Currently, substantially all fees paid pursuant to the Investor C Plan
are paid to compensate Selling Agents for providing the services described in
(i) and (iii) above, with any remaining amounts being used by the Distributor to
partially defray other expenses incurred by the Distributor in distributing
Investor C Shares. Fees received by the Distributor pursuant to the Investor C
Plan will not be used to pay any interest expenses, carrying charges or other
financing costs (except to the extent permitted by the SEC) and will not be used
to pay any general and administrative expenses of the Distributor.
Pursuant to the Investor C Plan, the Distributor may enter into Sales
Support Agreements with Selling Agents for providing sales support services to
their Customers who are the record or beneficial owners of Investor C Shares of
the Funds. Such Selling Agents will be compensated at the annual rate of up to
0.75% of the average daily net asset value of the Investor C Shares of the Funds
held of record or beneficially by such Customers. The sales support services
provided by Selling Agents may include providing distribution assistance and
promotional activities intended to result in the sales of shares such as paying
for the preparation, printing and distribution of prospectuses to other than
current shareholders.
50
<PAGE>
Fees paid pursuant to the Investor C Plan are accrued daily and paid monthly,
and are charged as expenses of the relevant shares of a Fund as accrued.
Expenses incurred by the Distributor pursuant to the Investor C Plan in any
given year may exceed the sum of the fees received under the Investor C Plan and
payments received pursuant to contingent deferred sales charges. Any such excess
may be recovered by the Distributor in future years so long as the Investor C
Plan is in effect. If the Investor C Plan were terminated or not continued, a
Fund would not be contractually obligated to pay the Distributor for any
expenses not previously reimbursed by the Fund or recovered through contingent
deferred sales charges.
In addition, the Directors have approved a Shareholder Servicing Plan
("Servicing Plan") with respect to the Investor C Shares of the Funds (the
"Investor C Servicing Plan"). Pursuant to the Investor C Servicing Plan, each
Fund may pay banks, broker/dealers or other financial institutions that have
entered into a Shareholder Servicing Agreement with Nations Fund ("Servicing
Agents") for certain expenses that are incurred by the Servicing Agents in
connection with shareholder support services that are provided by the Servicing
Agents. Payments under the Investor C Servicing Plan will be calculated daily
and paid monthly at a rate set from time to time by the Board of Directors,
provided that the annual rate may not exceed 0.25% of the average daily net
asset value of the Funds' Investor C Shares. The shareholder services provided
by the Servicing Agents may include (i) aggregating and processing purchase and
redemption requests for such Investor C Shares from Customers and transmitting
promptly net purchase and redemption orders to the Company's distributor or
transfer agent; (ii) providing Customers with a service that invests the assets
of their accounts in such Investor C Shares pursuant to specific or
pre-authorized instructions; (iii) processing dividend and distribution payments
from the Company on behalf of Customers; (iv) providing information periodically
to Customers showing their positions in such Investor C Shares; (v) arranging
for bank wires; (vi) responding to Customers' inquiries concerning their
investment in such Investor C Shares; (vii) providing subaccounting with respect
to such Investor C Shares beneficially owned by Customers or providing the
information necessary for subaccounting; (viii) if required by law, forwarding
shareholder communications from the Company (such as proxies, shareholder
reports, annual and semi-annual financial statements and dividend, distribution
and tax notices) to Customers; (ix) forwarding to Customers proxy statements and
proxies containing any proposals regarding the Shareholder Servicing Agreement;
(x) providing general shareholder liaison services; and (xi) providing such
other similar services as the Company may reasonably request to the extent the
Servicing Agent is permitted to do so under applicable statutes, rules or
regulations.
During the fiscal period ended March 31, 1996 the Distributor received
the following amounts from Rule 12b-1 fees, front end sales load fees and CDSC
fees in connection with Investor C Shares: $416.70, $0 and $0, respectively. Of
these amounts, the Distributor retained $318.73, $0 and $0, respectively, and
paid the balance to selling dealers.
Investor N Shares
The Directors of the Company have approved the Investor N Distribution
Plan in accordance with Rule 12b-1 under the 1940 Act with respect to Investor N
Shares of the Funds. Pursuant to the Investor N Distribution Plan, a Fund may
compensate or reimburse the Distributor for any activities or expenses primarily
intended to result in the sale of such Fund's Investor N Shares, including for
sales related services provided by Selling Agents. Payments under a Fund's
Investor N Distribution Plan will be calculated daily and paid monthly at a rate
or rates set from
51
<PAGE>
time to time by the Board of Directors provided that the annual rate may not
exceed 0.75% of the average daily net asset value of each Fund's Investor N
Shares.
The fees payable under the Investor N Distribution Plan are used
primarily to compensate or reimburse the Distributor for distribution services
provided by it, and related expenses incurred, including payments by the
Distributor to compensate or reimburse Selling Agents for sales support services
provided, and related expenses incurred, by such Selling Agents. Payments under
the Investor N Distribution Plan may be made with respect to: preparation,
printing and distribution of prospectuses, sales literature and advertising
materials by the Distributor or, as applicable, Selling Agents, attributable to
distribution or sales support activities, respectively; commissions, incentive
compensation or other compensation to, and expenses of, account executives or
other employees of the Distributor or Selling Agents, attributable to
distribution or sales support activities, respectively; overhead and other
office expenses of the Distributor relating to the foregoing (which may be
calculated as a carrying charge in the Distributor's or Selling Agents'
unreimbursed expenses), incurred in connection with distribution or sales
support activities. The overhead and other office expenses referenced above may
include, without limitation, (i) the expenses of operating the Distributor's or
Selling Agents' offices in connection with the sale of Fund shares, including
lease costs, the salaries and employee benefit costs of administrative,
operations and support personnel, utility costs, communication costs and the
costs of stationery and supplies, (ii) the costs of client sales seminars and
travel related to distribution and sales support activities, and (iii) other
expenses relating to distribution and sales support activities.
In addition, the Directors have approved a Shareholder Servicing Plan
with respect to Investor N Shares of the Funds (the "Investor N Servicing
Plan"). Pursuant to the Investor N Servicing Plan, a Fund may compensate or
reimburse banks, broker/dealers or other financial institutions that have
entered into a Shareholder Servicing Agreement with the Company ("Servicing
Agents") for certain activities or expenses of the Servicing Agents in
connection with shareholder services that are provided by the Servicing Agents.
Payments under the Investor N Servicing Plan will be calculated daily and paid
monthly at a rate or rates set from time to time by the Board of Directors,
provided that the annual rate may not exceed 0.25% of the average daily net
asset value of the Investor N Shares of the Funds.
The fees payable under the Investor N Servicing Plan are used primarily
to compensate or reimburse Servicing Agents for shareholder services provided,
and related expenses incurred, by such Servicing Agents. The shareholder
services provided by Servicing Agents may include: (i) aggregating and
processing purchase and redemption requests for such Investor N Shares from
Customers and transmitting promptly net purchase and redemption orders to the
Distributor or Transfer Agent; (ii) providing Customers with a service that
invests the assets of their accounts in such Investor N Shares pursuant to
specific or pre-authorized instructions; (iii) processing dividend and
distribution payments from the Company on behalf of Customers; (iv) providing
information periodically to Customers showing their positions in such Investor N
Shares; (v) arranging for bank wires; (vi) responding to Customers' inquiries
concerning their investment in such Investor N Shares; (vii) providing
sub-accounting with respect to such Investor N Shares beneficially owned by
Customers or providing the information necessary for sub-accounting; (viii) if
required by law, forwarding shareholder communications from the Company (such as
proxies, shareholder reports, annual and semi-annual financial statements and
dividend, distribution and tax notices) to Customers; (ix) forwarding to
Customers proxy statements and proxies containing any proposals regarding the
Investor N Servicing Plan or related agreements; (x) providing general
shareholder liaison services; and (xi) providing such other similar services as
the Company may reasonably
52
<PAGE>
request to the extent such Servicing Agent is permitted to do so under
applicable statutes, rules or regulations.
The fees payable under the Investor N Distribution Plan and Investor N
Servicing Plan (together, the "Investor N Plans") are treated by the Funds as an
expense in the year they are accrued. At any given time, a Selling Agent and/or
Servicing Agent may incur expenses in connection with services provided pursuant
to its agreements with the Distributor under the Investor N Plans which exceed
the payments made to the Selling Agents and Servicing Agents by the Distributor
or Nations Fund and reimbursed by the Fund pursuant to the Investor N Plans. Any
such excess expenses may be recovered in future years, so long as the Investor N
Plans are in effect. Because there is no requirement under the Investor N Plans
that the Distributor be paid or the Selling Agents and Servicing Agents be
compensated or reimbursed for all their expenses or any requirement that the
Investor N Plans be continued from year to year, such excess amount, if any,
does not constitute a liability to a Fund or the Distributor. Although there is
no legal obligation for the Fund to pay expenses incurred by the Distributor, a
Selling Agent or a Servicing Agent in excess of payments previously made to the
Distributor under the Investor N Plans or in connection with CDSCs, if for any
reason the Investor N Plans are terminated, the Directors will consider at that
time the manner in which to treat such expenses.
During the fiscal period ended March 31, 1996 the Distributor received
the following amounts from Rule 12b-1 fees and CDSC fees in connection with
Investor N Shares: $10,535 and $1,208, respectively. Of these amounts, the
Distributor retained $0 and $0, respectively, and paid the balance to selling
dealers.
Information Applicable to Investor A, Investor C and Investor N Shares
The Investor A Plan, the Investor C Plan, the Investor C Servicing
Plan, the Investor N Distribution Plan and the Investor N Servicing Plan (each a
"Plan" and collectively the "Plans") may only be used for the purposes specified
above and as stated in each such Plan. Compensation payable to Selling Agents or
Servicing Agents for shareholder support services under the Plans is subject to,
among other things, the National Association of Securities Dealers, Inc.'s
("NASD") Rules of Fair Practice governing receipt by NASD members of shareholder
servicing plan fees from registered investment companies (the "NASD Servicing
Plan Rule"), which became effective on July 7, 1993. Such compensation shall
only be paid for services determined to be permissible under the NASD Servicing
Plan Rule.
Each Plan requires the officers of the Company or the Distributor to
provide the Board of Directors at least quarterly with a written report of the
amounts expended pursuant to the Plan and the purposes for which such
expenditures were made. The Board of Directors reviews these reports in
connection with their decisions with respect to the Plans.
As required by Rule 12b-1 under the 1940 Act, each Plan was approved by
the Board of Directors, including a majority of the directors who are not
"interested persons" (as defined in the 1940 Act) of the Company and who have no
direct or indirect financial interest in the operation of the Plan or in any
agreements related to the Plan ("Qualified Directors") on January 26, 1995. The
Plans continue in effect as long as such continuance is specifically approved at
least annually by the Board of Directors, including a majority of the Qualified
Directors.
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<PAGE>
In approving the Plans in accordance with the requirements of Rule 12b-1, the
directors considered various factors and determined that there is a reasonable
likelihood that each Plan will benefit the respective Investor A, Investor C or
Investor N Shares and the holders of such shares. The Plans were approved by
their initial shareholders on June 30, 1995.
Each Plan may be terminated with respect to its shares by vote of a
majority of the Qualified Directors or by vote of a majority of holders of its
outstanding voting securities. Any change in a Plan that would increase
materially the distribution expenses paid by the Investor A, Investor C or
Investor N Shares requires shareholder approval; otherwise, each Plan may be
amended by the directors, including a majority of the Qualified Directors, by
vote cast in person at a meeting called for the purpose of voting upon such
amendment. The Investor C Servicing Plan and the Investor N Servicing Plan may
be terminated by a vote of a majority of the Qualified Directors. As long as a
Plan is in effect, the selection or nomination of the Qualified Directors is
committed to the discretion of the Qualified Directors.
Conflict of interest restrictions may apply to the receipt by Selling, and/or
Servicing Agents of compensation from Nations Fund in connection with the
investment of fiduciary assets in Investor Shares. Selling and/or Servicing
Agents, including banks regulated by the Comptroller of the Currency, the
Federal Reserve Board, or the Federal Deposit Insurance Corporation, and
investment advisers and other money maneuvers subject to the jurisdiction of the
SEC, the Department of Labor, or state securities commissions, are urged to
consult their legal advisers before investing such assets in Investor Shares.
Fees Paid Pursuant to Shareholder Servicing/Distribution Plans
Investor A Shares
Net
Fees Paid (12b-1
Component)
FUND Period ended 3/31/96
Nations Pacific Growth Fund $ 1,033.75
Nations Emerging Markets Fund 275.74
Nations Global Government Income 6,269.09
Fund
54
<PAGE>
Paid Pursuant to Distribution Plans
Investor C Shares
<TABLE>
<CAPTION>
Net
Fees Paid
Net (Shareholder
Fees Paid (12b-1 Servicing
Component) Component)
FUND Period ended 3/31/96 Period ended 3/31/96
<S> <C> <C>
Nations Pacific Growth Fund $ 197.36 $ 76.62
Nations Emerging Markets Fund 63.22 24.86
Nations Global Government Income 38.44 16.51
Fund
</TABLE>
NOTE: All fees paid under the Investor A and Investor C Shares Distribution
Plans were accrued as payments to broker/dealers and financial
institutions offering such shares to their customers.
Investor N Shares
<TABLE>
<CAPTION>
Net
Fees Paid
Net (Shareholder
Fees Paid (12b-1 Servicing
Component) Component)
FUND Period ended 3/31/96 Period ended 3/31/96
<S> <C> <C>
Nations Pacific Growth Fund $ 6,310.31 $ 2,103.44
Nations Emerging Markets Fund 3,590.06 1,196.69
Nations Global Government Income 634.62 211.54
Fund
</TABLE>
Shareholder Administration Plan (Primary B Shares)
As stated in the Prospectus describing the Primary B Shares, the Company
has a separate Shareholder Administration Plan (the "Administration Plan") with
respect to such shares. Pursuant to the Administration Plan, the Company may
enter into agreements ("Administration Agreements") with broker/dealers, banks
and other financial institutions that are dealers of record or holders of record
or which have a servicing relationship with the beneficial owners of Primary B
Shares ("Servicing Agents"). The Administration Plan provides that pursuant to
the Administration Agreements, Servicing Agents shall provide the shareholder
support services as set forth therein to their Customers who may from time to
time own of record or beneficially Primary B Shares in consideration for the
payment of up to 0.60% (on an annualized basis) of the net asset value of such
shares. Such services may include: (i) aggregating and processing purchase,
exchange and redemption requests for Primary B Shares from Customers and
55
<PAGE>
transmitting promptly net purchase and redemption orders with the Distributor or
the transfer agents; (ii) providing Customers with a service that invests the
assets of their accounts in Primary B Shares pursuant to specific or
pre-authorized instructions; (iii) processing dividend and distribution payments
from the Company on behalf of Customers; (iv) providing information periodically
to Customers showing their positions in Primary B Shares; (v) arranging for bank
wires; (vi) responding to Customer inquiries concerning their investment in
Primary B Shares; (vii) providing sub-accounting with respect to Primary B
Shares beneficially owned by Customers or the information necessary for
sub-accounting; (viii) if required by law, forwarding shareholder communications
(such as proxies, shareholder reports annual and semi-annual financial
statements and dividend, distribution and tax notices) to Customers; (ix)
forwarding to Customers proxy statements and proxies containing any proposals
regarding an Administration Agreement; (x) employee benefit plan recordkeeping,
administration, custody and trustee services; (xi) general shareholder liaison
services; and (xii) providing such other similar services as may reasonably be
requested to the extent permitted under applicable statutes, rules, or
regulations.
The Administration Plan also provides that in no event may the portion of
the shareholder administration fee that constitutes a "service fee," as the term
is defined in the NASD Servicing Plan Rule, exceed 0.25% of the average daily
net asset value of the Primary B Shares a Fund. In addition, to the extent any
portion of the fees payable under the Plan is deemed to be for services
primarily intended to result in the sale of Fund Primary B Shares, such fees are
deemed approved and may be paid under the Administration Plan. Accordingly, the
Administration Plan has been approved and will be operated pursuant to Rule
12b-1 under the 1940 Act. Such Plan shall continue in effect as long as the
Board of Directors, including a majority of the Qualified Directors,
specifically approves the Plan at least annually.
Expenses
The Administrator and/or Co-Administrator furnishes, without additional
cost to the Company, the services of the Treasurer and Secretary of the Company
and such other personnel (other than the personnel of the Adviser or
Sub-Adviser) as are required for the proper conduct of the Company's affairs.
The Distributor bears the incremental expenses of printing and distributing
prospectuses used by the Distributor or furnished by the Distributor to
investors in connection with the public offering of the Company's Shares and the
costs of any other promotional or sales literature, except that to the extent
permitted under the Plans relating to the Investor A, Investor C and Investor N
Shares of each Fund, sales-related expenses incurred by the Distributor may be
reimbursed by the Company.
The Company pays, or causes to be paid, all other expenses of the
Company, including without limitation: the fees of the Adviser, the Sub-Adviser,
the Administrator and Co- Administrator; the charges and expenses of any
registrar, any custodian or depository appointed by the Company for the
safekeeping of its cash, fund securities and other property, and any stock
transfer, dividend or accounting agent or agents appointed by the Company;
brokerage commissions chargeable to the Company in connection with fund
securities transactions to which the Company is a party; all taxes, including
securities issuance and transfer taxes; corporate fees payable by the Company to
Federal, state or other governmental agencies; all costs and expenses in
connection with the registration and maintenance of registration of the Company
and its shares with the SEC and various states and other jurisdictions
(including filing fees, legal fees and disbursements of counsel); the costs and
expenses of typesetting prospectuses and statements of additional information of
the Company (including supplements thereto) and periodic reports and of
56
<PAGE>
printing and distributing such prospectuses and statements of additional
information (including supplements thereto) to the Company's shareholders; all
expenses of shareholders' and directors' meetings and of preparing, printing and
mailing proxy statements and reports to shareholders; fees and travel expenses
of directors or director members of any advisory board or committee; all
expenses incident to the payment of any dividend or distribution, whether in
shares or cash; charges and expenses of any outside service used for pricing of
the Company's shares; fees and expenses of legal counsel and of independent
auditors in connection with any matter relative to the Company; membership dues
of industry associations; interest payable on Company borrowings; postage and
long-distance telephone charges; insurance premiums on property or personnel
(including officers and directors) of the Company which inure to its benefit;
extraordinary expenses (including, but not limited to, legal claims and
liabilities and litigation costs and any indemnification related thereto); and
all other charges and costs of the Company's operation unless otherwise
explicitly assumed by the Adviser (and/or the Sub-Adviser), the Administrator or
Co-Administrator.
Expenses of the Company which are not directly attributable to the
operations of any class of shares or Fund are pro-rated among all classes of
shares or Funds of the Company based upon the relative net assets of each class
or Fund. Expenses of the Company which are not directly attributable to a
specific class of shares but are directly attributable to a specific Fund are
prorated among all the classes of shares of such Fund based upon the relative
net assets of each such class of shares. Expenses of the Company which are
directly attributable to a class of shares are charged against the income
available for distribution as dividends to such class of shares.
The Investment Advisory Agreement, the Sub-Advisory Agreement and the
Administration Agreement require the Adviser, the Sub-Adviser and the
Administrator to reduce their fees to the extent required to satisfy any expense
limitations which may be imposed by the securities laws or regulations
thereunder of any state in which a Fund's shares are registered or qualified for
sale, as such limitations may be raised or lowered from time to time and the
aggregate of all such investment advisory, sub-advisory and administration fees
shall be reduced by the amount of such excess. The amount of any such reduction
to be borne by the Adviser, the Sub-Adviser or the Administrator shall be
deducted from the monthly investment advisory and administration fees otherwise
payable to the Adviser, the Sub-Adviser and the Administrator during such fiscal
year. If required pursuant to such state securities regulations, the Adviser,
the Sub-Adviser and the Administrator will reimburse the Company no later than
the last day of the first month of the next succeeding fiscal year, for any such
annual operating expenses (after reduction of all investment advisory and
administration fees in excess of such limitation).
Transfer Agents and Custodian
First Data Investors Services Group, Inc., formerly The Shareholder
Services Group, Inc., a wholly owned subsidiary of First Data Corporation, is
located at One Exchange Place, 53 State Street, Boston, Massachusetts 02109, and
acts as transfer agent (the "Transfer Agent") for the Company's Primary Shares
and Investor Shares. Under a transfer agency agreement, the Transfer Agent
maintains shareholder account records for the Company, handles certain
communications between shareholders and the Company, distributes dividends and
distributions payable by the Company to shareholders and produces statements
with respect to account activity for the Company and its shareholders for these
services. The Transfer Agent receives a monthly fee computed on the basis of the
number of shareholder accounts that it maintains for the Company during the
month and is reimbursed for out-of-pocket expenses. NationsBank of Texas, N.A.
57
<PAGE>
("NationsBank of Texas"), 901 Main Street, Dallas, Texas 75201, serves as
sub-transfer agent for each Fund's Primary Shares.
Bank of New York serves as custodian (the "Custodian") for the
portfolio securities and cash of the Funds. The Custodian maintains custody of
the Funds' securities cash and other property, delivers securities against
payment upon sale and pays for securities against delivery upon purchase, makes
payments on behalf of the Funds for payments of dividends, distributions and
redemptions, endorses and collects on behalf of the Funds all checks, and
receives all dividends and other distributions made on securities owned by the
Funds. The Custodian receives compensation from the Funds for its services based
on a percentage of the market value of the Funds' securities and a charge for
fund transactions.
INDEPENDENT ACCOUNTANT AND REPORTS
At least semi-annually, the Company will furnish shareholders of the
Funds with a list of the investments held in the Funds and financial statements
for the Funds. The annual financial statements will be audited by the Company's
independent accountant. The Board of Directors has selected Price Waterhouse
LLP, 160 Federal Street, Boston, Massachusetts 02110 as the Company's
independent accountant to audit the Company's books and review the Company's tax
returns for the Funds' fiscal years ending on and after March 31, 1996.
The Company's audited Financial Statements for the fiscal period ended
March 31, 1996 appearing in the Company's Annual Report are incorporated by
reference in this SAI.
COUNSEL
Morrison & Foerster LLP serves as legal counsel to the Company. Its
address is 2000 Pennsylvania Avenue, N.W., Washington, D.C. 20006.
ADDITIONAL INFORMATION ON PERFORMANCE
Yield information and other performance information for the Company's
Funds may be obtained by calling the Company at (800) 321-7854.
From time to time, the yield and total return of a Fund's Investor
Shares and Primary Shares may be quoted in advertisements, shareholder reports,
and other communications to shareholders. Each Fund of the Company also may
quote information obtained from the Investment Company Institute in its
advertising materials and sales literature. In addition, certain potential
benefits of investing in world securities markets may be discussed in
promotional materials. Such benefits include, but are not limited to: a) the
expanded opportunities for investment in securities markets outside the U.S.; b)
the growth of securities markets outside the U.S. vis-a-vis U.S. markets; c) the
relative return associated with foreign securities markets vis-a- vis U.S.
markets; and d) a reduced risk of portfolio volatility resulting from a
diversified securities portfolio consisting of both U.S. and foreign securities.
Performance information is available by calling 1-800-321-7854 with respect to
Investor Shares and 1-800-621-2192 with respect to Primary Shares.
Yield Calculations
58
<PAGE>
The yield of the Primary Shares and Investor Shares of the Funds is a measure of
the net investment income per share (as defined) earned over a 30-day period
expressed as a percentage of the maximum offering price of a share of such
classes at the end of the period. Yield figures are determined by dividing the
net investment income per share earned during the specified 30-day period by the
maximum offering price per share on the last day of the period, according to the
following formula:
Yield = 2[(a-b + 1)6 1]
cd
Where: a = dividends and interest earned during the period
b = expenses accrued for the period (net of reimbursements)
c = average daily number of shares outstanding during the
period that were entitled to receive dividends
d = maximum offering price per share on the last day of the
period
For purposes of yield quotation, income is calculated in accordance
with standardized methods applicable to all stock and bond mutual funds. In
general, interest income is reduced with respect to bonds trading at a premium
over their par value by subtracting a portion of the premium from income on a
daily basis, and is increased with respect to bonds trading at a discount by
adding a portion of the discount to daily income. Capital gains and losses are
excluded from the calculation.
Income calculated for the purposes of calculating a Fund's yield
differs from income as determined for other accounting purposes. Because of the
different accounting methods used, and because of the compounding assumed in
yield calculations, the yield quoted for a Fund may differ from the rate of
distributions a Fund paid over the same period or the rate of income reported in
the Funds' financial statements.
Total Return Calculations
Total return measures both the net investment income generated by, and
the effect of any realized or unrealized appreciation or depreciation of the
underlying investments in a Fund. The Funds' average annual and cumulative total
return figures are computed in accordance with the standardized methods
prescribed by the SEC.
Average annual total return figures are computed by determining the
average annual compounded rates of return over the periods indicated in the
advertisement, sales literature or shareholders' report that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
P(1 + T)n = ERV
Where: P = a hypothetical initial payment of 1,000
T = average annual total return
59
<PAGE>
n = number of years
ERV = ending redeemable value at the end of the period of a
hypothetical 1,000 payment made at the beginning of
such period
This calculation (i) assumes all dividends and distributions are reinvested at
net asset value on the appropriate reinvestment dates as described in the
Prospectuses, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial 1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
Cumulative total return is computed by finding the cumulative
compounded rate of return over the period indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
CTR = (ERV-P) 100
P
Where: CTR = Cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical 1,000 payment made at the beginning of
such period
P = initial payment of 1,000.
This calculation (i) assumes all dividends and distributions are reinvested at
net asset value on the appropriate reinvestment dates as described in the
Prospectuses, and (ii) deducts (a) the maximum sales charge from the
hypothetical initial 1,000 investment, and (b) all recurring fees, such as
advisory and administrative fees, charged as expenses to all shareholder
accounts.
Based on the foregoing calculations, the Funds' average annual return
for all classes of shares were as follows for the period from
inception through March 31, 1996:
<TABLE>
<CAPTION>
Aggregate Total Returns
Inception Through Inception Through
3/31/96 Without 3/31/96 Including
Sales Charges Sales Charges
<S> <C> <C>
Emerging Markets
Primary A. Shares 3.42% N/A
Primary B Shares N/A N/A
Investor A Shares 3.20% N/A
Investor C Shares 2.70% 2.20%
Investor N Shares 2.60% N/A
Pacific Growth
Primary A Shares 2.66% N/A
Primary B Shares N/A N/A
Investor A Shares 2.52% N/A
60
<PAGE>
Investor C Shares 2.00% 1.50%
Investor N Shares 1.88% N/A
Global Government
Primary A Shares 5.03% N/A
Primary B Shares N/A N/A
Investor A Shares 4.84% N/A
Investor C Shares 4.40% 3.90%
Investor N Shares 4.27% N/A
</TABLE>
The Primary Shares and Investor Shares of the Funds may also quote
their distribution rates, which express the historical amount of income
dividends paid to their shareholders during a one-month (in the case of the
Global Government Income Fund) or a three-month (in the case of the Emerging
Markets Fund and Pacific Growth Fund) period as a percentage of the maximum
offering price per share on the last day of such period.
The performance figures of the Funds as described above will vary from
time to time depending upon market and economic conditions, the composition of
their portfolios and operating expenses. These factors should be considered when
comparing the performance figures of the Funds with those of other investment
companies and investment vehicles.
The Funds may compare the performance and yield of a class or series of
shares to those of other mutual funds with similar investment objectives and to
other relevant indices or to rankings prepared by independent services or other
financial or industry publications that monitor the performance of mutual funds.
For example, the performance and yield of a class of shares in a Fund may be
compared to data prepared by Lipper Analytical Services, Inc. Performance and
yield data as reported in national financial publications such as Money
Magazine, Forbes, Barron's, The Wall Street Journal, and The New York Times, or
in publications of a local or regional nature, also may be used in comparing the
performance of a class of shares in a Fund.
In addition, the performance and yield of a class of shares in the
Emerging Markets Fund and Pacific Growth Fund may be compared to the Standard &
Poor's 500 Stock Index, an unmanaged index of a group of common stocks, the
Consumer Price Index, the Dow Jones Industrial Average, a recognized unmanaged
index of common stocks of 30 industrial companies listed on the New York Stock
Exchange or the Europe, Far East and Australia Index, a recognized unmanaged
index of international stocks. The performance and yield of a class of shares in
the Global Government Income Fund may be compared to the Lehman Brothers
Government/Corporate Bond Index, an unmanaged index of U.S. government, treasury
and agency securities, corporate and yankee bonds, the Salomon Brothers
Long-Term-High-Grade Corporate Bond Index, an unmanaged index of nearly all U.S.
"Aaa-" and "Aa-" rated bonds or international bond index. Any given performance
comparison should not be considered representative of a Fund's performance for
any future period.
MISCELLANEOUS
61
<PAGE>
Certain Record Holders
The following indicates those persons who owned 5% or more of the
indicated class of shares as of July 2, 1996.
<TABLE>
<CAPTION>
Percentage of Shares
Name and Address Held of Record Only
<S> <C>
Nations Emerging Markets Fund
Primary A Shares
PT NationsBank 37.05%
101 South Tryon Street
Charlotte, NC 28255
Investor A Shares
None
Investor C Shares
Willie E. Elston & 25.66%
Mary L. Elston JTWROS
7919 Wingate Drive
Glenn Dale, MD 20769
Dean Witter Reynolds Cust. For 10.95%
David G. Elmer
IRA Std/Rollover DTD 7/18/95
191 Second Avenue
Dayton, TN 37321
Renee A. Kriz 10.86%
7212 Rolling Road
Springfield, VA 22152-3652
Youssef I A Talaat Cust For 8.34%
Ashraf Y Talaat VA/UTMA
7383 Jiri Woods Ct.
Springfield, VA 22153
Youssef I A Talaat Cust For 8.34%
Adham Y Talaat VA/UTMA
7383 Jiri Woods Ct.
Springfield, VA 22153
62
<PAGE>
Nations Global Government
Income Fund
Primary A Shares
PT NationsBank 50.52%
101 South Tryon Street
Charlotte, NC 28255
Investor A Shares
None
Investor C Shares
None
Investor N Shares 58.34%
Dixie Restaurant & Equipment Co. Inc.
2734 Spring Garden Road
Winston Salem, NC 27106-5714
Shirley M. Clark Family Trust 19.60%
Shirley M. Clark TTEE DTD 11/30/92
14131 Woodstream
San Antonio, TX 78231
Charlotte S. Copeland 8.40%
103 Quail Drive Meadowbrook
Summerville, SC 29485
Dean Witter Reynolds Cust For 5.66%
Sandra D. Riggs
IRA Standard Dated 08/08/94
1608 Summerwood Trail
Hixson, TN 37343
Nations Pacific Growth Fund
Primary A Shares
PT NationsBank 18.12%
101 South Tryon Street
Charlotte, NC 28255
Investor A Shares 8.38%
Ron Underwood &
David Brown TTEES
Dallas Heart Group, 401K Plan
8440 Walnut Hill Lane, Suite 700
63
<PAGE>
Dallas, TX 75231
Kenneth D. Lewis 6.92%
2525 Richardson Drive
Charlotte, NC 28211
Investor C Shares
Carolyn Branan 34.17%
19209 Hidden Cove Lane
Huntersville, NC 28078
BSDT Cust Rollover IRA FBO 20.35%
Rosemary L. Waring
4601 Anson Court
Plano, TX 75024
Dean Witter Reynolds Cust 7.02%
For Jean M. De Ru IRA
2664 Sharondale Drive
Atlanta, GA 30305-3858
William D. Ratliff III 6.99%
801 Cherry Street, Suite 1300
Fort Worth, TX 76102
</TABLE>
As of July 2, 1996, NationsBank Corporation and its affiliates owned of
record more than 25% of the outstanding shares of the Company acting as agent,
fiduciary, or custodian for its customers and may be deemed a controlling person
of the Company under the 1940 Act.
64
<PAGE>
SCHEDULE A
DESCRIPTION OF RATINGS
The following summarizes the highest six ratings used by Standard &
Poor's Corporation ("S&P") for corporate and municipal bonds. The first four
ratings denote investment grade securities.
AAA - This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay interest
and repay principal.
AA - Debt rated AA is considered to have a very strong
capacity to pay interest and repay principal and differs from AAA
issues only in a small degree.
A - Debt rated A has a strong capacity to pay interest and
repay principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
BBB - Debt rated BBB is regarded as having an adequate
capacity to pay interest and repay principal. Whereas it normally
exhibits 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 debt in this category than for
those in higher-rated categories.
BB, B - Bonds rated BB and B are regarded, on balance as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with
the terms of the obligation. Debt rated BB has less near-term
vulnerability to default than other speculative issues. However, it
faces major ongoing uncertainties or exposure to adverse business,
financial, or economic conditions which could lead to inadequate
capacity to meet timely interest and principal payments. Debt rated B
has a greater vulnerability to default but currently has the capacity
to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal.
To provide more detailed indications of credit quality, the AA, A and
BBB, BB and B ratings may be modified by the addition of a plus or minus sign to
show relative standing within these major rating categories.
The following summarizes the highest six ratings used by Moody's
Investors Service, Inc. ("Moody's") for corporate and municipal bonds. The first
four denote investment grade securities.
Aaa - Bonds that are rated Aaa are judged to be of the
best quality. They carry the smallest degree of investment risk and are
generally referred to as "gilt edge." Interest payments are protected
by a large or by an exceptionally stable margin and principal is
secure. While the various protective elements are likely to change,
such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
A-1
<PAGE>
Aa - Bonds that 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 that are rated A possess many favorable
investment attributes and are to be considered 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 that are rated Baa are considered medium grade
obligations, i.e., they are neither highly protected nor poorly
secured. Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds
lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba - Bonds that are rated Ba are judged to have speculative
elements; their future cannot be considered as well assured. Often the
protection of interest and principal payments may be very moderate and
thereby not as well safeguarded during both good times and bad times
over the future. Uncertainty of position characterizes bonds in this
class.
B - Bonds that are rated B generally lack characteristics of
the desirable investment. Assurance of interest and principal payments
or of maintenance of other terms of the contract over any long period
of time may be small.
Moody's applies numerical modifiers (1, 2 and 3) with respect to
corporate bonds rated Aa through B. The modifier 1 indicates that the bond being
rated ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the bond ranks
in the lower end of its generic rating category. With regard to municipal bonds,
those bonds in the Aa, A and Baa groups which Moody's believes possess the
strongest investment attributes are designated by the symbols Aa1, A1 or Baa1,
respectively.
The following summarizes the highest four ratings used by Duff & Phelps
Credit Rating Co. ("D&P") for bonds, each of which denotes that the securities
are investment grade.
AAA - Bonds that are rated AAA are of the highest credit
quality. The risk factors are considered to be negligible, being only
slightly more than for risk-free U.S.
Treasury debt.
AA - Bonds that are rated AA are of high credit quality.
Protection factors are strong. Risk is modest but may vary slightly
from time to time because of economic conditions.
A - Bonds that are rated A have protection factors which are
average but adequate. However, risk factors are more variable and
greater in periods of economic stress.
A-2
<PAGE>
BBB - Bonds that are rated BBB have below average protection factors
but still are considered sufficient for prudent investment.
Considerable variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may modified by the addition of a plus or minus sign to show
relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch
Investors Service, Inc. ("Fitch") for bonds, each of which denotes that the
securities are investment grade:
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 issuers is generally rated F-1+.
A - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes
in economic conditions and circumstances than bonds with higher
ratings.
BBB - Bonds 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
adverse impact on these bonds, and therefore impair timely payment. The
likelihood that the ratings of these bonds will fall below investment
grade is higher than for bonds with higher ratings.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may be modified by the addition of a plus or minus sign to show
relative standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for
short-term municipal notes and variable-rate demand obligations:
MIG-1/VMIG-1 -- Obligations bearing these designations are of
the best quality, enjoying strong protection from established cash
flows, superior liquidity support or demonstrated broad-based access to
the market for refinancing.
MIG-2/VMIG-2 -- Obligations bearing these designations are of
high quality, with ample margins of protection although not so large as
in the preceding group.
The following summarizes the two highest ratings used by S&P for
short-term municipal notes:
A-3
<PAGE>
SP-1 -- Very strong or strong capacity to pay principal and interest.
Those issues determined to possess overwhelming safety characteristics
are given a "plus" (+) designation.
SP-2 -- Satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of
which denotes that the securities are investment grade, are D-1, D-2, and D-3.
D&P employs three designations, D- 1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is judged to be "outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good fundamental protection factors. Risk factors are considered to be minor.
D-1 indicates high certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
D-2 indicates good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the two highest rating categories used by
Fitch for short-term obligations, each of which denotes that the securities are
investment grade:
F-1+ securities possess exceptionally strong credit quality.
Issues assigned this rating are regarded as having the strongest degree
of assurance for timely payment.
F-1 securities possess very strong credit quality. Issues
assigned this rating reflect an assurance of timely payment only
slightly less in degree than issues rated F-1+.
F-2 securities possess good credit quality. Issues carrying
this rating have a satisfactory degree of assurance for timely payment,
but the margin of safety is not as great as for issues assigned the
F-1+ and F-1 ratings.
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
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 senior short-term
promissory obligations. Issuers rated Prime-2 (or related supporting
institutions) are considered to have a strong capacity for repayment of senior
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
trends and coverage ratios, while sound, will be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
For commercial paper, D&P uses the short-term debt ratings described
above.
A-4
<PAGE>
For commercial paper, Fitch uses the short-term debt ratings described above.
Thomson BankWatch, Inc. ("BankWatch") ratings are based upon a
qualitative and quantitative analysis of all segments of the organization
including, where applicable, holding company and operating subsidiaries.
BankWatch ratings do not constitute a recommendation to buy or sell securities
of any of these companies. Further, BankWatch does not suggest specific
investment criteria for individual clients.
BankWatch long-term ratings apply to specific issues of long-term debt
and preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA - The highest category; indicates ability to repay
principal and interest on a timely basis is extremely high.
AA - The second highest category; indicates a very strong
ability to repay principal and interest on a timely basis with limited
incremental risk versus issues rated in the highest category.
A - The third highest category; indicates the ability to repay
principal and interest is strong. Issues rated "A" could be more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
BBB - The lowest investment grade category; indicates an
acceptable capacity to repay principal and interest. Issues rated "BBB"
are, however, more vulnerable to adverse developments (both internal
and external) than obligations with higher ratings.
Long-term debt ratings may include a plus (+) or minus (-)
sign to indicate where within a category the issue is placed.
The BankWatch short-term ratings apply to commercial paper, other
senior short-term obligations and deposit obligations of the entities to which
the rating has been assigned. The BankWatch short-term ratings specifically
assess the likelihood of an untimely payment of principal or interest.
TBW-1 The highest category; indicates a very high likelihood that
principal and interest will be paid on a timely basis.
TBW-2 The second highest category; while the degree of safety
regarding timely repayment of principal and interest is
strong, the relative degree of safety is not as high as for
issues rated "TBW-1".
TBW-3 The lowest investment grade category; indicates that while
more susceptible to adverse developments (both internal and
external) than obligations with higher ratings, capacity to
service principal and interest in a timely fashion is
considered adequate.
A-5
<PAGE>
TBW-4 The lowest rating category; this rating is regarded as
non-investment grade and therefore speculative.
The following summarizes the four highest long-term debt ratings used by IBCA
Limited and its affiliate, IBCA Inc. (collectively, "IBCA"):
AAA - Obligations for which there is 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 for which there is 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.
A - Obligations for which there is a low expectation of
investment risk. Capacity for timely repayment of principal and
interest is strong, although adverse changes in business, economic or
financial conditions may lead to increased investment risk.
BBB - Obligations for which there is currently a low
expectation of investment risk. Capacity for timely repayment of
principal and interest is adequate, although adverse changes in
business, economic or financial conditions are more likely to lead to
increased investment risk than for obligations in other categories.
A plus or minus sign may be appended to a rating below AAA to
denote relative status within major rating categories.
The following summarizes the two highest short-term debt ratings used by IBCA:
A1+ When issues possess a particularly strong credit feature, a
rating of A1+ is assigned.
A-1 Obligations supported by the highest capacity for timely repayment.
A2 Obligations supported by a good capacity for timely repayment.
A-6
<PAGE>
SCHEDULE B
ADDITIONAL INFORMATION CONCERNING
OPTIONS & FUTURES
As stated in the Prospectuses, each Fund may enter into futures contracts
and options for hedging purposes. Such transactions are described in this
Schedule. During the current fiscal year, each of the Funds intends to limit its
transactions in futures contracts and options so that not more than 5% of the
Fund's net assets are at risk. Furthermore, in no event would any Fund purchase
or sell futures contracts, or related options thereon, for hedging purposes if,
immediately thereafter, the aggregate initial margin that is required to be
posted by the Fund under the rules of the exchange on which the futures contract
(or futures option) is traded, plus any premiums paid by the Fund on its open
futures options positions, exceeds 5% of the Fund's total assets, after taking
into account any unrealized profits and unrealized losses on the Fund's open
contracts and excluding the amount that a futures option is "in-the-money" at
the time of purchase. (An option to buy a futures contract is "in-the-money" if
the value of the contract that is subject to the option exceeds the exercise
price; an option to sell a futures contract is "in-the-money" if the exercise
price exceeds the value of the contract that is subject of the option.)
Interest Rate Futures Contracts.
Use of Interest Rate Futures Contracts. Bond prices are established in both
the cash market and the futures market. In the cash market, bonds are purchased
and sold with payment for the full purchase price of the bond being made in
cash, generally within five business days after the trade. In the futures
market, only a contract is made to purchase or sell a bond in the future for a
set price on a certain date. Historically, the prices for bonds established in
the futures market have tended to move generally in the aggregate in concert
with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Fund may use interest rate futures as a defense,
or hedge, against anticipated interest rate changes and not for speculation. As
described below, this would include the use of futures contract sales to protect
against expected increases in interest rates and futures contract purchases to
offset the impact of interest rate declines.
A Fund presently could accomplish a similar result to that which it hopes
to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by the Fund, through using futures contracts.
Description of Interest Rates Futures Contracts. An interest rate futures
contract sale would create an obligation by a Fund, as seller, to deliver the
specific type of financial instrument called for in the contract at a specific
future time for a specified price. A futures contract purchase would create an
obligation by the Fund, as purchaser, to take delivery of the specific type of
financial instrument at a specific future time at a specific price. The specific
securities delivered or taken, respectively, at settlement date, would not be
determined until at or near that date. The determination would be in accordance
with the rules of the exchange on which the futures contract sale or purchase
was made.
B-1
<PAGE>
Although interest rate futures contracts by their terms call for actual delivery
or acceptance of securities, in most cases the contracts are closed out before
the settlement date without the making or taking of delivery of securities.
Closing out a futures contract sale is effected by the Fund's entering into a
futures contract purchase for the same aggregate amount of the specific type of
financial instrument and the same delivery date. If the price in the sale
exceeds the price in the offsetting purchase, the Fund is paid the difference
and thus realizes a gain. If the offsetting purchase price exceeds the sale
price, the Fund pays the difference and realizes a loss. Similarly, the closing
out of a futures contract purchase is effected by the Fund's entering into a
futures contract sale. If the offsetting sale price exceeds the purchase price,
the Fund realizes a gain, and if the purchase price exceeds the offsetting sale
price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on the
floors of several exchanges - principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. A Fund would deal
only in standardized contracts on recognized changes. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term U.S. Treasury Bonds and Notes; GNMA modified
pass-through mortgagee- backed securities; three-month U.S. Treasury Bills; and
ninety-day commercial paper. The Funds may trade in any futures contract for
which there exists a public market, including, without limitation, the foregoing
instruments.
Examples of Futures Contract Sale. A Fund would engage in an interest rate
futures contract sale to maintain the income advantage from continued holding of
a long-term bond while endeavoring to avoid part or all of the loss in market
value that would otherwise accompany a decline in long-term securities prices.
For example, assume that the market value of a certain security in a Fund tends
to move in concert with the futures market prices of long-term U.S. Treasury
bonds. The investment adviser wishes to fix the current market value of this
portfolio security until some point in the future. Assume the portfolio security
has a market value of 100, and the investment adviser believes that, because of
an anticipated rise in interest rates, the value will decline to 95. The Fund
might enter into futures contract sales of Treasury bonds for an equivalent of
98. If the market value of the portfolio securities does indeed decline from 100
to 95, the equivalent futures market price for the Treasury bonds might also
decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The investment adviser could be wrong in its forecast of interest rates and
the equivalent futures market price could rise above 98. In this case, the
market value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
losses realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example might
incur a loss of 2 points (which might be reduced by an offsetting transaction
prior to the settlement date). In each transaction, transaction expenses would
also be incurred.
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Examples of Future Contracts Purchases. A Fund would engage in an interest rate
futures contract purchase when it is not fully invested in long-term bonds but
wishes to defer for a time the purchase of long-term bonds in light of the
availability of advantageous interim investments, e.g., shorter-term securities
whose yields are greater than those available on long-term bonds. The Fund's
basic motivation would be to maintain for a time the income advantage from
investing in the short-term securities; the Fund would be endeavoring at the
same time to eliminate the effect of all or part of an expected increase in
market price of the long-term bonds that the Fund may purchase.
For example, assume that the market price of a long-term bond that the Fund
may purchase, currently yielding 10%, tends to move in concert with futures
market prices of Treasury bonds. The investment adviser wishes to fix the
current market price (and thus 10% yield) of the long-term bond until the time
(four months away in this example) when it may purchase the bond. Assume the
long-term bond has a market price of 100, and the investment adviser believes
that, because of an anticipated fall in interest rates, the price will have
risen to 105 (and the yield will have dropped to about 9-1/2%) in four months.
The Fund might enter into futures contracts purchases of Treasury bonds for an
equivalent price of 98. At the same time, the Fund would assign a pool of
investments in short-term securities that are either maturing in four months or
earmarked for sale in four months, for purchase of the long-term bond at an
assumed market price of 100. Assume these short-term securities are yielding
15%. If the market price of the long-term bond does indeed rise from 100 to 105,
the equivalent futures market price for Treasury bonds might also rise from 98
to 103. In that case, the 5-point increase in the price that the Fund pays for
the long-term bond would be offset by the 5-point gain realized by closing out
the futures contract purchase.
The investment adviser could be wrong in its forecast of interest rates;
long-term interest rates might rise to above 10%; and the equivalent futures
market price could fall below 98. If short-term rates at the same time fail to
10% or below, it is possible that the Fund would continue with its purchase
program for long-term bonds. The market price of available long-term bonds would
have decreased. The benefit of this price decrease, and thus yield increase,
will be reduced by the loss realized on closing out the futures contract
purchase.
If, however, short-term rates remained above available long-term rates, it
is possible that the Fund would discontinue its purchase program for long-term
bonds. The yield on short-term securities in the portfolio, including those
originally in the pool assigned to the particular long-term bond, would remain
higher than yields on long-term bonds. The benefit of this continued incremental
income will be reduced by the loss realized on closing out the futures contract
purchase.
In each transaction, expenses also would be incurred.
Index Futures Contracts.
A stock or bond index assigns relative values to the stocks or bonds
included in the index, and the index fluctuates with changes in the market
values of the stocks or bonds included. Some stock index futures contracts are
based on broad market indices, such as the Standard & Poor's 500 Composite Stock
Price Index or the New York Stock Exchange Composite Index. In contrast, certain
exchanges offer futures contracts on narrower market indices, such as the
Standard & Poor's 100, the Bond Buyer Municipal Bond Index, an index composed of
40 term revenue and general obligation bonds, or indices based on an industry or
market segment, such as oil and gas
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stocks. Futures contracts are traded on organized exchanges regulated by the
CFTC. Transactions on such exchanges are cleared through a clearing corporation,
which guarantees the performance of the parties to each contract.
A Fund will sell index futures contracts in order to offset a decrease in
market value of its portfolio securities that might otherwise result from a
market decline. The Fund may do so either to hedge the value of its portfolio as
a whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, a Fund will purchase
index futures contracts in anticipation of purchases of securities. In a
substantial majority of these transactions, the Fund will purchase such
securities upon termination of the long futures position, but a long futures
position may be terminated without a corresponding purchase of securities.
In addition, a Fund may utilize index futures contracts in anticipation of
changes in the composition of its portfolio holdings. For example, in the event
that a Fund expects to narrow the range of industry groups represented in its
holdings it may, prior to making purchases of the actual securities, establish a
long futures position based on a more restricted index, such as an index
comprised of securities of a particular industry group. A Fund also may sell
futures contracts in connection with this strategy, in order to protect against
the possibility that the value of the securities to be sold as part of the
restructuring of the portfolio will decline prior to the time of sale.
The following are examples of transactions in stock index futures (net of
commissions and premiums, if any).
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objection: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/
Increase in Purchase Contract
Price = $2,500 Gain on Futures = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1.0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted
Equity Portfolio-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Gain on Futures = $40,00
Value = $40,000
If, however, the market moved in the opposite direction, that is,
market value decreased and the Fund had entered into an anticipatory purchase
hedge, or market value increased and the Fund had hedged its stock portfolio,
the results of the Fund's transactions in stock index futures would be as set
forth below.
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ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/
Contract
-Day Hedge is Lifted
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost - $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Loss on Futures = $2,500
Price= $2,500 Contract
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors:
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index = 1.0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted
Equity Portfolio-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Portfolio = $40,000 Loss on Futures = $40,000
Margin Payments
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to deposit with the broker or in a segregated account
with the Fund's custodian an amount of cash or cash equivalents, the value, of
which may vary but is generally equal to, 10% or less of the value of the
contract. This amount is known as initial margin. The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin
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does not involve the borrowing of funds by the customer to finance the
transactions. Rather, the initial margin is in the nature of a performance bond
or good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract assuming all contractual obligations have
been satisfied. Subsequent payments, called variation margin, to and from the
broker, will be made on a daily basis as the price of the underlying security or
index fluctuates making the long and short positions in the futures contract
more or less valuable, a process known as marking to the market. For example,
when a Fund has purchased a futures contract and the price of the contract has
risen in response to a rise in the underlying instruments, that position will
have increased in value and the Fund will be entitled to receive from the broker
a variation margin payment equal to that increase in value. Conversely, where a
Fund has purchased a futures contract and the price of the futures contract has
declined in response to a decrease in the underlying instruments, the position
would be less valuable, and the Fund would be required to make a variation
margin payment to the broker. At any time prior to expiration of the futures
contract, the investment adviser may elect to close the position by taking an
opposite position, subject to the availability of a secondary market, which will
operate to terminate the Fund's position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid by or released to the Fund, and the Fund realizes a loss or gain.
Risks of Transactions in Futures Contracts
There are several risks in connection with the use of futures by a Fund as
a hedging device. One risk arises because of the imperfect correlation between
movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the future moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of the
securities being hedged has moved in an unfavorable direction, the Fund would be
in a better position than if it had not hedged at all. If the price of the
securities being hedged has moved in a favorable direction, this advance will be
partially offset by the loss on the future. If the price of the future moves
more than the price of the hedged securities, the Fund involved will experience
either a loss or gain on the future which will not be completely offset by
movements in the price of the securities which are the subject of the hedge.
To compensate for the imperfect correlation of movements in the price of
securities being hedged and movements in the price of futures contracts, a Fund
may buy or sell futures contracts in a greater dollar amount than the dollar
amount of securities being hedged if the volatility over a particular time
period of the prices of such securities has been greater than the volatility
over such time period of the future, or if otherwise deemed to be appropriate by
the investment adviser. Conversely, a Fund may buy or sell fewer futures
contracts if the volatility over a particular time period of the prices of the
securities being hedged is less than the volatility over such time period of the
futures contract being used, or if otherwise deemed to be appropriate by the
investment adviser. It also is possible that, where a Fund has sold futures to
hedge its portfolio against a decline in the market, the market may advance, and
the value of securities held by the Fund may decline. If this occurred, the Fund
would lose money on the future and also experience a decline in value in its
portfolio securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for
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other reasons, the Fund will realize a loss on the futures contract that is not
offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's custodian
and/or in a margin account with a broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the securities
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. Rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced, thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the investment adviser still may not
result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. However, in the event futures contracts have been used to
hedge portfolio securities, such securities will not be sold until the futures
contract can be terminated. In such circumstances, an increase in the price of
the securities, if any, may partially or completely offset losses on the futures
contract. However, as described above, there is no guarantee that the price of
the securities will in fact correlate with the price movements in the futures
contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Fund also is subject to the investment
adviser's ability to predict correctly movements in the direction of the market.
For example, if a Fund has hedged against the possibility of a decline in the
market adversely affecting securities held in its portfolio and securities
prices increase instead, the Fund will lose part or all of the benefit to 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 Fund has insufficient cash, it may have to sell securities to meet
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daily variation margin requirements. Such sales of securities may be, but will
not necessarily be, at increased prices which reflect the rising market. A Fund
may have to sell securities at a time when it may be disadvantageous to do so.
Options on Futures Contracts.
The Funds may purchase options on the futures contracts described above. A
futures option gives the holder, in return for the premium paid, the right to
buy (call) from or sell (put) to the writer of the option a futures contract at
a specified price at any time during the period of the option. Upon exercise,
the writer of the option is obligated to pay the difference between the cash
value of the futures contract and the exercise price. Like the buyer or seller
of a futures contract, the holder, or writer, of an option has the right to
terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). In addition, the purchase of an
option also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the option purchased.
Depending on the pricing of the option compared to either the futures contract
upon which it is based, or upon the price of the securities being hedged, an
option may or may not be less risky than ownership of the futures contract or
such securities. In general, the market prices of options can be expected to be
more volatile than the market prices on the underlying futures contract.
Compared to the purchase or sale of futures contracts, however, the purchase of
call or put options on futures contracts may frequently involve less potential
risk to a Fund because the maximum amount at risk is the premium paid for the
options (plus transaction costs). Although permitted by their fundamental
investment policies, the Funds do not currently intend to write futures options,
and will not do so in the future absent any necessary regulatory approvals.
Accounting and Tax Treatment.
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles. Generally, futures contracts and
options on futures contracts held by a Fund at the close of the Fund's taxable
year will be treated for Federal income tax purposes as sold for their fair
market value on the last business day of such year, a process known as
"marking-to-market." Forty percent (40%) of any gains or loss resulting from
such constructive sale will be treated as short-term capital gain or loss and
sixty percent (60%) of such gain or loss will be treated as long-term capital
gain or loss without regard to the length of time the Fund holds the futures
contract or option (the "40%-60% rule"). The amount of any capital gain or loss
actually realized by a Fund in a subsequent sale or other disposition of those
futures contracts will be adjusted to reflect any capital gain or loss taken
into account by the Fund in a prior year as a result of the constructive sale of
the contracts and options. With respect to futures contracts to sell or options
which will be regarded as parts of a "mixed straddle" because their values
fluctuate inversely to the values of specific securities held by the Fund,
losses as to such contracts to sell or options will be subject to certain loss
deferral rules which limit the amount of loss currently deductible on either
part of the straddle to the amount thereof which exceeds the unrecognized gain
(if any) with respect to the other part of the straddle, and to certain wash
sales regulations. Under short sales rules, which also will be applicable, the
holding period of the securities forming part of the straddle will (if they have
not been held for the long-term holding period) be deemed not to
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begin prior to termination of the straddle. With respect to certain futures
contracts and options, deductions for interest and carrying charges will not be
allowed. Notwithstanding the rules described above, with respect to futures
contracts to sell which are properly identified as such and certain options, a
Fund may make an election which will except (in whole or in part) those
identified futures contracts or options from being treated for Federal income
tax purposes as sold on the last business day of the Fund's taxable year, but
gains and losses will be subject to such short sales, wash sales, loss deferral
rules and the requirement to capitalize interest and carrying charges. Under
temporary regulations, a Fund would be allowed (in lieu of the foregoing) to
elect to either ( 1 ) offset gains or losses from portions which are part of a
mixed straddle by separately identifying each mixed straddle to which such
treatment applies, or (2) establish a mixed straddle account for which gains and
losses would be recognized and offset on a periodic basis during the taxable
year. Under either election, the 40%-60% rule will apply to the net gain or loss
attributable to the futures contracts, but in the case of a mixed straddle
account election, not more than 50% of any net gain may be treated as long-term
and not more than 40% of any net loss may be treated as short-term.
Certain foreign currency contracts entered into by a Fund may be subject to
the "marking-to-market" process and the 40%-60% rule in a manner similar to that
described in the preceding paragraph for futures contracts and options on
futures contracts. To receive such Federal income tax treatment, a foreign
currency contract must meet the following conditions: (1) the contract must
require delivery of a foreign currency of a type in which regulated futures
contracts are traded or upon which the settlement value of the contract depends;
(2) the contract must be entered into at arm's length at a price determined by
reference to the price in the interbank market; and (3) the contract must be
traded in the interbank market. The Treasury Department has broad authority to
issue regulations under the provisions respecting foreign currency contracts.
Other foreign currency contracts entered into by a Fund may result in the
creation of one or more straddles for Federal income tax purposes, in which case
certain loss deferral, short sales, and wash sales rules and the requirement to
capitalize interest and carrying charges may apply.
As described more full in the section of the SAI entitled "Additional
Information Concerning Taxes," in order to qualify as a regulated investment
company under the Code a Fund must derive less than 30% of its gross income from
investments held for less than three months. With respect to futures contracts
and other financial instruments subject to the marking-to-market rules, the
Internal Revenue Service has ruled in private letter rulings that a gain
realized from such a futures contract or financial instrument will be treated as
being derived from a security held for three months or more (regardless of the
actual period for which the contract or instrument is held) if the gain arises
as a result of a constructive sale under the marking-to-market rules, and will
be treated as being derived from a security held for less than three months only
if the contract or instrument is terminated (or transferred) during the taxable
year (other than by reason of marking-to-market) and less than three months have
elapsed between the date the contract or instrument is acquired and the
termination date. In determining whether the 30% test is met for a taxable year,
increases and decreases in the value of each Fund's futures contracts and other
investments that qualify as part of a "designated hedge," as defined in the
Code, may be netted.
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SCHEDULE C
ADDITIONAL INFORMATION CONCERNING
MORTGAGE-BACKED SECURITIES
Mortgage-Backed Securities
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to an investor.
Most issuers or poolers provide guarantees of payments, regardless of whether or
not the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit, collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance purchased
by the issuer. There can be no assurance that the private issuers or poolers can
meet their obligations under the policies. Mortgage-backed securities issued by
private issuers or poolers, whether or not such securities are subject to
guarantees, may entail greater risk than securities directly or indirectly
guaranteed by the U.S. Government.
Interests in pools of mortgage-backed securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
residential mortgage loans, net of any fees paid. Additional payments are caused
by repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure net of fees or costs which may be incurred. Some
mortgage-backed securities are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation (FHLMC). FHLMC is a corporate instrumentality of the U.S. Government
and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. Its stock is owned by
the twelve Federal Home Loan Banks. FHLMC issues Participation Certificates
("PC's"), which represent interests in mortgages from FHLMC's national
portfolio. FHLMC guarantees the timely payment of interest and ultimate
collection of principal.
The Federal National Mortgage Association (FNMA) is a Government
sponsored corporation owned entirely by private stockholders. It is subject to
general regulation by the Secretary of Housing and Urban Development. FNMA
purchases residential mortgages from a list of approved sellers/servicers which
include state and federally-chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest be FNMA.
The principal government guarantor of mortgage-backed securities is the
Government National Mortgage Association (GNMA). GNMA is a wholly-owned U.S.
Government
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corporation within the Department of Housing and Urban Development. GNMA is
authorized to guarantee, with the full faith and credit of the U.S. Government,
the timely payment of principal and interest on securities issued by approved
institutions and backed by pools of FHA-insured or VA-guaranteed mortgages.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than Government and Government-related pools because there are no
direct or indirect Government guarantees of payments in the former pools.
However, timely payment of interest and principal of these pools is supported by
various forms of insurance or guarantees, including individual loan, title, pool
and hazard insurance purchased by the issuer. The insurance and guarantees are
issued by Governmental entities, private insurers, and the mortgage poolers.
There can be no assurance that the private insurers or mortgage poolers can meet
their obligations under the policies.
The Funds expect that Governmental or private entities may create
mortgage loan pools offering pass through investments in addition to those
described above. The mortgages underlying these securities may be alternative
mortgage instruments, that is, mortgage instruments whose principal or interest
payment may vary or whose terms to maturity may be shorter than previously
customary. As new types of mortgage-backed securities are developed and offered
to investors, certain Funds will, consistent with their investment objectives
and policies, consider making investments in such new types of securities.
Underlying Mortgages
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. The terms
and characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, a Fund may purchase pools of variable-rate mortgages
("VRMs"), growing equity mortgages ("GEM"), graduated payment mortgages ("GPM")
and other types where the principal and interest payment procedures vary. VRMs
are mortgages which reset the mortgage's interest rate periodically with changes
in open market interest rates. To the extent that the Fund is actually invested
in VRMs, the Fund's interest income will vary with changes in the applicable
interest rate on pools of VRMs. GPM and GEM pools maintain constant interest
rates, with varying levels of principal repayment over the life of the mortgage.
These different interest and principal payment procedures should not impact the
Fund's net asset value since the prices at which these securities are valued
will reflect the payment procedures.
All poolers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Poolers also establish
credit standards and underwriting criteria for individual mortgages included in
the pools. In addition, some mortgages included in pools are insured through
private mortgage insurance companies.
Average Life
The average life of pass-through pools varies with the maturities of
the underlying mortgage instruments. In addition, a pool's term may be shortened
by unscheduled or early
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payments of principal and interest on the underlying mortgages. The occurrence
of mortgage prepayments is affected by factors including the level of interest
rates, general economic conditions, the location and age of the mortgage, and
other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed-rated 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with other
maturities or different characteristics will have varying assumptions for
average life.
Returns on Mortgage-Backed Securities
Yields on mortgage-backed pass-through securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield.
Reinvestment of prepayments may occur at higher or lower interest rates
than the original investment, thus affecting the yields of the Fund. The
compounding effect from reinvestments of monthly payments received by the Fund
will increase its yield to shareholders, compared to bonds that pay interest
semi-annually.
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