<PAGE>
- FPA Capital Fund, Inc. -
- -
PROSPECTUS
FPA Capital Fund, Inc.
seeks long-term capital
growth. Current income is
a secondary consideration.
The Fund's investment
adviser, First Pacific
Advisors, Inc., invests
the Fund's assets in
common stocks and other
securities which it
believes have the
potential to increase in
market value. Fund shares
are presently offered for
sale only to existing
shareholders and to
directors, officers and
employees of the Fund, the
Adviser, and affiliated
companies.
THE SECURITIES AND
EXCHANGE COMMISSION HAS
NOT APPROVED OR
DISAPPROVED THESE
SECURITIES OR PASSED UPON
THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE
CONTRARY IS A CRIMINAL
OFFENSE.
AUGUST 1, 2000
[LOGO]
DISTRIBUTOR:
FPA FUND DISTRIBUTORS, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, CA 90064
- -
- -
<PAGE>
FPA CAPITAL FUND, INC.
11400 West Olympic Boulevard, Suite 1200
Los Angeles, California 90064
(310) 473-0225
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
Risk/Return Summary......................................... 3
Investment Results.......................................... 5
Fees and Expenses of the Fund............................... 6
Investment Objective, Principal Investment Strategies, and
Principal Risks............................................ 7
Management and Organization................................. 8
Purchase, Pricing and Sale of Shares........................ 9
Exchange of Shares and Shareholder Services................. 13
Dividends, Distributions and Taxes.......................... 15
Financial Highlights........................................ 17
</TABLE>
2
<PAGE>
RISK/RETURN SUMMARY
INVESTMENT OBJECTIVE. The Fund's primary investment objective is long-term
growth of capital. Current income is a secondary consideration.
WHO MAY WANT TO INVEST IN THE FUND? Shares of the Fund are presently offered
for sale only to existing shareholders and to directors, officers and employees
of the Fund, the Adviser, and affiliated companies. The Fund may be appropriate
for investors:
- Seeking long-term growth of capital
- Willing to own shares over the course of a market cycle or longer
PRINCIPAL INVESTMENT STRATEGIES. The Adviser purchases common stocks it
believes undervalued when considering various valuation criteria. The Adviser
deems the following attributes of companies important in its stock selection
process:
- Current as well as future levels of profitability
- Book value
- Replacement cost of assets
- Free cash flow
PRINCIPAL INVESTMENTS. The Fund invests primarily in the common stocks of U.S.
companies in a variety of industries and market segments. The Fund can also
invest in both government and corporate debt securities, preferred stocks and
convertible securities. Up to 15% of the Fund's assets may be invested in
lower-rated or comparable unrated debt securities. No more than 10% of the
Fund's assets will be invested in the securities of foreign issuers.
PRINCIPAL INVESTMENT RISKS. You can lose money by investing in the Fund for
many reasons, including:
- The U.S. or foreign stock market goes down.
- The market favors growth stocks over value stocks or favors companies at a
different capitalization level.
- The Fund's value-oriented investment approach could result in an emphasis
on medium and smaller sized companies. Investing in smaller companies
generally involves greater risk than investing in larger companies. Also,
the portfolio might not reflect all facets of the national economy and
could differ significantly from broad market indicies.
- An adverse event, such as an unfavorable earnings report, depresses the
value of a particular stock.
- Prices of the Fund's foreign securities go down because of unfavorable
changes in foreign currency exchange rates, foreign government actions,
political instability or other factors that can adversely affect
investments in foreign countries.
3
<PAGE>
- Changes in market prices and the assets of the Fund may from time to time
cause more of the Fund's assets to be invested in securities of a single
company, which increases the volatility of the Fund.
- To the extent that convertible securities or other debt securities
acquired by the Fund are rated lower than investment grade or are not
rated, there is a greater risk as to the timely repayment of principal and
interest.
An investment in the Fund is not a bank deposit and is not insured or guaranteed
by the Federal Deposit Insurance Company or any other government agency.
4
<PAGE>
INVESTMENT RESULTS
The bar chart and table below provide an indication of the risk of investing in
the Fund by showing changes in the Fund's performance from year to year and by
showing how the Fund's average annual returns for 1, 5, and 10 years compare
with those of a broad measure of market performance. The Fund's past performance
is not necessarily an indication of how the Fund will perform in the future.
Here are the Fund's results calculated without a sales
charge on a CALENDAR YEAR basis. (If a sales charge were
included, results would be lower.)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
1990 -13.80%
1991 64.51%
1992 21.57%
1993 16.74%
1994 10.37%
1995 38.38%
1996 37.76%
1997 17.70%
1998 -0.42%
1999 14.24%
</TABLE>
The year to date return for the Fund as of June 30, 2000 was (1.16%).
The Fund's highest/lowest QUARTERLY results during this time period were:
<TABLE>
<S> <C> <C>
HIGHEST 36.98% (Quarter ended 03/31/91)
LOWEST (31.24)% (Quarter ended 09/30/90)
</TABLE>
The table below shows how the Fund's average annual returns after deduction of
the maximum sales charge for one, five and ten calendar years compared with
those of the Russell 2000 Index and the Lipper Mid-Cap Value Fund Average.
For the periods ended December 31, 1999:
<TABLE>
<CAPTION>
FUND WITH LIPPER
MAXIMUM MID-CAP
SALES CHARGE RUSSELL VALUE FUND
AVERAGE ANNUAL TOTAL RETURN DEDUCTED 2000* AVERAGE*
--------------------------- ------------ -------- ----------
<S> <C> <C> <C>
One Year............................................... 6.81 % 21.26 % 9.33%
Five Years............................................. 19.00 % 16.69 % 16.55%
Ten Years.............................................. 18.15 % 13.40 % 12.71%
</TABLE>
------------
* The Russell 2000 Index consists of the 2,000 smallest companies in the Russell
3000 total capitalization universe. This index is considered a measure of
small capitalization stock performance and is included as a broad-based
comparison to the capitalization characteristics of the Fund's portfolio. The
Lipper Mid-Cap Value Fund Average provides an additional comparison of how the
Fund performed in relation to other mutual funds with similar objectives.
5
<PAGE>
FEES AND EXPENSES OF THE FUND
THE FOLLOWING DESCRIBES THE FEES AND EXPENSES THAT YOU MIGHT PAY IF YOU BUY AND
HOLD SHARES OF THE FUND.
<TABLE>
<S> <C>
SHAREHOLDER FEES
(FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum Sales Load Imposed on Purchases (as a
percentage of offering price)....................... 6.50%
Maximum Deferred Sales Load (as a percentage of
original sales price or redemption proceeds, as
applicable)......................................... *
Redemption Fee (as a percentage of amount
redeemed)........................................... None**
Exchange Fee........................................ $5.00
ANNUAL FUND OPERATING EXPENSES
(EXPENSES THAT ARE DEDUCTED FROM FUND ASSETS)
Management Fees..................................... 0.66%
Distribution (12b-1) Fees........................... None
Other Expenses (including financial services)....... 0.20%
------
Total Annual Fund Operating Expenses................ 0.86%
</TABLE>
------------
* An account management fee is charged by unaffiliated investment advisers or
broker-dealers to certain accounts entitled to purchase shares without sales
charge.
**Redemptions by wire are subject to a $3.50 charge per wire.
EXAMPLE
This Example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds.
The Example assumes you invest $10,000 in the Fund for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Example also assumes that your investment has a 5% return each year and that the
Fund's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your costs would be:
<TABLE>
<S> <C>
One year.................................................... $ 732
Three years................................................. $ 907
Five years.................................................. $1,096
Ten years................................................... $1,642
</TABLE>
6
<PAGE>
INVESTMENT OBJECTIVE, PRINCIPAL INVESTMENT STRATEGIES, AND PRINCIPAL RISKS
INVESTMENT OBJECTIVE. The Fund's primary investment objective is long-term
growth of capital. Providing you current income is a secondary consideration.
The Fund seeks to make your investment grow over the long-term by investing
principally in common stocks the Adviser deems to possess above-average ability
to increase in market value.
PRINCIPAL INVESTMENT STRATEGIES. The Fund's Adviser favors investments in
common stocks it believes undervalued when considering various valuation
criteria. The Adviser deems the following important in its stock selection
process: current as well as future levels of profitability, book value,
replacement cost of assets and free cash flow. The Adviser attempts to lessen
price risk by not overpaying for earnings of even the best companies.
Furthermore, investments tend to be focused in areas viewed as temporarily
out-of-favor, as evidenced by such factors as low price-to-normalized earnings
ratios and price-to-book value ratios. Normalized earnings are used in an
attempt to reduce the effect of one-time or extraordinary items that may distort
the normal or anticipated recurring earnings from the operations of the company.
The Fund also invests in debt securities, but to a lesser extent. Debt
securities are selected using an investment approach similar to that of equities
and may include United States Government and government agency obligations,
corporate debt securities, preferred stocks and convertible securities. Lower
rated or comparable unrated debt securities may comprise up to 15% of net
assets.
For temporary defensive purposes or in response to adverse market conditions,
the Fund may take larger than usual positions in cash or high-quality short-term
debt securities (U.S. government or government agency securities, obligations of
domestic banks, prime commercial paper notes and repurchase agreements). As a
result, you may not achieve your investment objectives in the short-term.
The Fund relies on the professional judgment of its Adviser to make decisions
about the Fund's portfolio securities. The Adviser's basic investment philosophy
is to purchase securities on the basis of fundamental value and earnings
expectations rather than short-term stock market expectations.
PRINCIPAL RISKS. Your investment in the Fund is subject to a number of risks
related to principal investment strategies, including the following.
- The Adviser's emphasis on a value-oriented investment approach generally
results in the Fund's portfolio being invested primarily in medium or
smaller sized companies. Smaller companies typically are subject to a
greater degree of change in earnings and business prospects than larger,
more established companies. In addition, securities of smaller companies
are traded in lower volumes than those issued by larger companies and may
be more volatile. Consequently, the Fund may be subject to greater risk
than if it invested in larger companies.
- Fund shares could decline in value in response to certain events, such as
changes in markets or economies.
- The prices of equity securities held by the Fund can be affected by events
specifically involving the issuers of these securities.
- The prices of debt securities held by the Fund can be affected by changing
interest rates (as interest rates rise, the prices of debt securities
fall), effective maturities and credit ratings.
7
<PAGE>
- Investing outside the U.S. can also involve additional risks, such as
currency fluctuations and political, social and economic instability.
- Although the Fund may not invest more than 5% of its total assets in the
securities of any one issuer (except the U.S. Government) at the time of
purchase, changes in market prices and the assets of the Fund may from
time to time cause more than 5% or even 10% of the Fund's assets to be
invested in securities of a single company. Such relative concentration is
likely to increase the volatility of the Fund's net asset value per share.
- To the extent that convertible securities or other debt securities
acquired by the Fund are rated lower than investment grade or are not
rated, there is a greater risk as to the timely repayment of principal and
interest. Decisions to purchase and sell these securities are based on the
Adviser's evaluation of their investment potential and not on the ratings
assigned by credit agencies. Because investment in lower-rated securities
involves greater investment risk, achievement of the Fund's investment
objective is more dependent on the Adviser's credit analysis than with
respect to the Fund's investments in higher-rated securities. Lower-rated
securities may be more susceptible to real or perceived adverse economic
and competitive industry conditions than investment grade securities. A
projection of an economic downturn, for example, could cause a decline in
the prices of lower-rated securities because a recession could lessen the
ability of a highly leveraged company to make principal and interest
payments on its debt securities. In addition, the secondary trading market
for lower-rated securities may be less liquid than the market for
higher-rated securities.
MANAGEMENT AND ORGANIZATION
DISCONTINUANCE OF SALES TO NEW INVESTORS
The Fund has discontinued indefinitely the sale of its shares to new investors,
except directors, officers and employees of the Fund, the Adviser and affiliated
companies. The Fund continues to accept additional investments from existing
shareholders, and continues to reinvest dividends and capital gains
distributions with respect to the accounts of existing shareholders who elect
such options. The decision to discontinue sales to new investors reflects
management's belief that, under current conditions, unrestrained growth in the
Fund's net assets might impair investment flexibility. The Fund may recommence
at any time the offering of shares to new investors if the Board of Directors
believes it would be in the best interests of the Fund and its shareholders.
INVESTMENT ADVISER
First Pacific Advisors, Inc. is the Fund's investment adviser. The Adviser,
together with its predecessors, has been in the investment advisory business
since 1954 and has served as the Fund's investment adviser since July 11, 1984.
The Adviser manages assets of approximately $3.1 billion for seven investment
companies, including one closed-end investment company, and 19 institutional
accounts. First Pacific Advisors, Inc. is headquartered at 11400 West Olympic
Boulevard, Suite 1200, Los Angeles, California 90064. The Adviser selects
investments for the Fund, provides administrative services and manages the
Fund's business. The total management fee paid by the Fund, as a percentage of
average net assets, for the previous fiscal year was 0.66%.
8
<PAGE>
The Adviser is an indirect, wholly owned subsidiary of United Asset
Management Corporation ("UAM"). UAM is a New York Stock Exchange listed holding
company principally engaged, through affiliated firms, in providing
institutional investment management and acquiring institutional investment
management firms. UAM has announced an agreement to be acquired by Old Mutual
plc, a United Kingdom-based financial services group with substantial asset
management, insurance and banking businesses. The board of directors of the Fund
has been informed by the Adviser that no changes in the operations of the
Adviser are currently planned which would affect the services being provided to
the Fund. The acquisition will constitute an assignment which under the
Investment Company Act will terminate the current investment advisory agreement
between the Adviser and the Fund. The Adviser proposes a new investment advisory
agreement identical to the current agreement in all respects except for its
effective and termination dates. A new investment advisory agreement requires
approval by the board of directors of the Fund and by shareholders of the Fund.
<PAGE>
PORTFOLIO MANAGER
Robert L. Rodriguez, President of the Fund, and Principal, Chief Executive
Officer, Chief Investment Officer and director of the Adviser, is primarily
responsible for the day-to-day management of the Fund's portfolio.
Mr. Rodriguez has been the Chief Investment Officer of the Fund for over 16
years.
PURCHASE, PRICING AND SALE OF SHARES
PURCHASE AND INVESTMENT MINIMUMS. You can purchase shares, if you fall into one
of the classes of investors described above, by contacting any investment dealer
authorized to sell the Fund's shares. You can use the account information form
for initial purchases. The minimum initial investment is $1,500, and each
subsequent investment must be at least $100. All purchases made by check should
be in U.S. dollars and made payable to the FPA Funds or State Street Bank and
Trust Company. Third party checks will not be accepted. A charge may be imposed
if a check does not clear.
SHARE PRICE. The Fund calculates its share price, also called net asset value,
as of 4:00 p.m. New York time, which is the normal close of trading on the New
York Stock Exchange ("NYSE"), every day the NYSE is open. The NYSE is closed
most national holidays and Good Friday. Share price is rounded to the nearest
cent per share and equals the market value of all portfolio securities plus
other assets, less all liabilities, divided by the number of Fund shares
outstanding. Orders received by dealers before the NYSE closes on any business
day are priced based on the share price for that day if Boston Financial Data
Services, Inc. receives the order prior to its close of business at 4:00 p.m.
Eastern time. Orders received by Boston Financial Data Services, Inc. after such
time generally are priced based on the share price for the next business day.
However, orders received by certain retirement plans and certain other financial
intermediaries before the NYSE closes and communicated to Boston Financial Data
Services, Inc. by 9:30 a.m., Eastern time, on the following business day are
priced at the share price for the prior business day. Share prices for sales
(redemptions) of Fund shares is the first share price determined after Boston
Financial Data Services, Inc. receives a properly completed request, except that
sale orders received by an authorized dealer, certain retirement plans and
certain other financial intermediaries before the NYSE closes are priced at the
closing price for that day if communicated to Boston Financial Data
Services, Inc. within the times specified above.
SALES CHARGES. The offering price is the share price plus any applicable sales
charge. A sales charge may apply to your purchase. As indicated in the table
below, your sales charge can be reduced for larger purchases. You, your spouse
and the following related people (and their spouses) can combine investments to
reduce your sales charge: grandparents, parents, siblings, children or
grandchildren; or by the
9
<PAGE>
individual, his or her spouse and a trustee or other fiduciary purchasing
securities for related trusts, estates or fiduciary accounts, including employee
benefit plans.
<TABLE>
<CAPTION>
SALES SALES REALLOWED
SIZE OF INVESTMENT CHARGE(1) CHARGE(2) TO DEALERS(2)
------------------ --------- --------- -------------
<S> <C> <C> <C>
Less than $10,000.......................................... 6.95% 6.50% 6.00%
$10,000 but less than $25,000.............................. 6.38% 6.00% 5.50%
$25,000 but less than $50,000.............................. 5.54% 5.25% 4.75%
$50,000 but less than $100,000............................. 4.71% 4.50% 4.25%
$100,000 but less than $250,000............................ 3.90% 3.75% 3.50%
$250,000 but less than $500,000............................ 2.04% 2.00% 1.75%
$500,000 but less than $1,000,000.......................... 1.01% 1.00% 0.80%
$1,000,000 and over........................................ 0.00% 0.00% 0.00%
</TABLE>
------------
(1) As a percentage of net amount invested.
(2) As a percentage of public offering price.
REDUCING YOUR SALES CHARGE
INVESTMENTS IN OTHER FPA FUNDS. To determine the sales charge, you can add the
current value, at offering price, of all presently held shares of the FPA Funds,
which are:
- FPA Capital Fund, Inc. (this Fund, which is currently closed to new
investors)
- FPA New Income, Inc.
- FPA Paramount Fund, Inc.
- FPA Perennial Fund, Inc.
If your holdings of other FPA Funds qualify you for a reduced sales charge, you
must provide information to verify your holdings.
LETTER OF INTENT. A letter of intent will allow you to obtain a reduced sales
charge by aggregating investments made during a thirteen-month period. The value
of all presently held shares of the FPA Funds (see above list) can also be used
to determine the applicable sales charge. The account information form contains
the Letter of Intent that must be signed at the time of initial purchase, or
within 30 days. Each investment made under a Letter of Intent during the period
receives the sales charge for the total investment goal. IF YOU DO NOT REACH
YOUR INVESTMENT GOAL, YOU MUST PAY THE DIFFERENCE BETWEEN THE SALES CHARGES
APPLICABLE TO THE AMOUNT PURCHASED MINUS THOSE ACTUALLY PAID.
PURCHASES NOT SUBJECT TO SALES CHARGE. You and your spouse (and your immediate
relatives) can purchase shares without a sales charge, if you fall into one of
the following categories and you represent that the shares you purchase are for
investment and will not be resold except through redemption or repurchase by the
Fund. Immediate relatives include grandparents, parents, siblings, children and
grandchildren of a qualified investor, and the spouse of any immediate relative.
10
<PAGE>
(a) current and former directors, officers and employees of the Adviser,
United Asset Management Corporation (the Adviser and FPA Fund
Distributors, Inc. are indirect wholly owned subsidiaries of United
Asset Management Corporation) and its affiliates;
(b) current and former directors, officers and employees of Angeles
Corporation (the former parent of the Adviser) and its affiliates;
(c) current and former directors of, and partners and employees of legal
counsel to, the investment companies advised by the Adviser;
(d) investment advisory clients of the Adviser and consultants to such
clients and their directors, officers and employees;
(e) employees (including registered representatives) of a dealer that has a
selling group agreement with FPA Fund Distributors, Inc. and consents to
the purchases;
(f) any employee benefit plan maintained for the benefit of such qualified
investors; and
(g) directors, officers and employees of a company whose employee benefit
plan holds shares of one or more of the FPA Funds.
Because FPA Fund Distributors, Inc. anticipates that certain purchases will
result in economies of scale in the sales effort and related expenses compared
to sales made through normal distribution channels, upon satisfaction of certain
conditions the following persons can purchase without a sales charge:
(a) trustees or other fiduciaries purchasing shares for employee benefit
plans of employers with 20 or more employees;
(b) trust companies, bank trust departments and registered investment
advisers purchasing for accounts over which they exercise investment
authority and which are held in a fiduciary, agency, advisory, custodial
or similar capacity, provided that the amount collectively invested or
to be invested by such accounts during the subsequent 13-month period in
the Fund or other FPA Funds totals at least $1,000,000;
(c) tax-exempt organizations enumerated in Section 501(c) (3), (9), or (13)
of the Internal Revenue Code; and
(d) accounts upon which an investment adviser, financial planner or
broker-dealer charges an account management or consulting fee, provided
it has entered into an agreement with FPA Fund Distributors, Inc.
regarding those accounts or purchases Fund shares for such accounts or
for its own accounts through an omnibus account maintained by a
broker-dealer that has entered into such an agreement with the Fund or
FPA Fund Distributors, Inc.
If you qualify, you must submit a special application form available from FPA
Fund Distributors, Inc. with your initial purchase, and you must notify FPA Fund
Distributors, Inc. of your eligibility when you place the order. If you place
the order through a broker, the broker may charge you a service fee. No such fee
is charged if you purchase directly from FPA Fund Distributors, Inc. or the
Fund.
11
<PAGE>
SELLING (REDEEMING) YOUR SHARES
You can sell (redeem) for cash without charge any or all of your Fund shares at
any time by sending a written request to Boston Financial Data Services, Inc.
Faxes are not acceptable. You can also place redemption requests through
dealers, but they may charge a fee. If you are selling Fund shares from a
retirement plan, you should consult the plan documentation concerning federal
tax consequences and consult your plan custodian about procedures.
A check will be mailed to you within seven days after Boston Financial Data
Services, Inc. receives a properly completed request (as described below under
"Written Requests"). If Fund shares sold were recently purchased by check,
payment of the redemption proceeds will be delayed until confirmation that the
purchase check has cleared, which may take up to 15 days from the date of
purchase.
WRITTEN REQUESTS. Requests must be signed by the registered shareholder(s). If
you hold a stock certificate, it must be included with your written request. A
signature guarantee is required if the redemption is:
- Over $10,000;
- Made payable to someone other than the registered shareholder or to
somewhere other than the registered address; or
- If the shareholder is a corporation, partnership, trust or fiduciary.
A signature guarantee can be obtained from a bank or trust company; a broker or
dealer; a credit union; a national securities exchange, registered securities
association or clearing agency; or a savings and loan association. Additional
documents are required for sales by corporations, partnerships, trusts,
fiduciaries, executors or administrators.
TELEPHONE TRANSACTIONS. You must elect the option on the account information
form to have the right to sell your shares by telephone. If you wish to make an
election to have the right to sell your shares via telephone or to change such
an election after opening an account, you will need to complete a request with a
signature guarantee. Sales via telephone are not available for shares held in a
Fund-sponsored retirement account or in certificate form.
When you obtain the right to sell your Fund shares by telephone, you may direct
that a check for the proceeds payable to the shareholder of record be mailed to
the address of record or you may designate a bank account to which the proceeds
of such redemptions are sent. Telephone redemptions over $5,000 which are sent
to your bank are wired unless the designated bank cannot receive Federal Reserve
wires, in which case the redemptions are mailed. Telephone redemptions under
$5,000 which are sent to the designated bank are mailed unless you request
otherwise. There is a $3.50 charge per wire. No telephone redemptions to the
address of record will be processed within 30 days of a change in the address of
record.
Boston Financial Data Services, Inc. uses procedures it considers reasonable to
confirm redemption instructions via telephone, including requiring account
registration verification from the caller and recording telephone instructions.
Neither Boston Financial Data Services, Inc. nor the Fund is liable for losses
due to unauthorized or fraudulent instructions if there is a reasonable belief
in the authenticity of
12
<PAGE>
received instructions and reasonable procedures are employed; otherwise, they
may be liable. During periods of significant economic or market changes, it may
be difficult to sell your shares by telephone.
The Fund can change or discontinue telephone redemption privileges without
notice.
REINVESTING IN THE FUND WITH PROCEEDS FROM REDEMPTION OF SHARES. If you
reinvest in the Fund within 30 days, you do not have to pay a sales charge. Your
reinvestment is made at the first share price determined after Boston Financial
Data Services, Inc. receives your order. You can only do this once for each Fund
investment, and you must provide sufficient information to verify your
reinvestment when you make your purchase. A sale and reinvestment is a taxable
transaction, but losses on the sale are not deductible for federal income tax
purposes.
AUTOMATIC REDEMPTION (SALE) OF YOUR SHARES. If as a result of a redemption your
account value is less than $500, the Fund can direct Boston Financial Data
Services, Inc. to sell your remaining Fund shares. In such case, you will be
notified in writing that your account value is insufficient and be given up to
60 days to increase it to $500.
EXCHANGE OF SHARES AND SHAREHOLDER SERVICES
EXCHANGING YOUR FUND SHARES
EXCHANGING YOUR SHARES FOR SHARES OF OTHER FPA FUNDS. You can exchange your
shares of the Fund for shares of other FPA Funds.
You can increase an existing account or start a new account in the selected FPA
Fund. Shares of the Fund acquired must be registered for sale in your state.
A $5.00 service fee applies to each exchange. In addition, a sales charge
applies unless:
- you paid a sales charge on the exchanged shares equivalent to that
applicable to the acquired shares;
- you are otherwise entitled to purchase shares without a sales charge (as
noted under "Purchases Not Subject to Sales Charge"); or
- the shares you are exchanging were acquired by reinvestment.
EXCHANGING YOUR SHARES FOR SHARES OF A MONEY MARKET FUND. FPA Fund
Distributors, Inc. has made arrangements to allow you to exchange your shares
for shares of the money market portfolio of the Cash Equivalent Fund, a no-load
diversified money market mutual fund. Shares of the money market fund you
acquire through exchange plus any shares acquired by reinvestment of dividends
and distributions may be re-exchanged for shares of any FPA Fund without a sales
charge. However, in the case of the Fund, you must have maintained your account
in the Fund in order to re-exchange your shares in the money market fund for
shares in the Fund. If your shares are held in a Fund-sponsored individual
retirement account, you cannot exchange them into shares of the money market
fund.
The $5.00 exchange fee is paid by FPA Fund Distributors, Inc., which receives a
fee from Kemper Financial Services, the administrator of the money market fund,
of 0.15 of 1% per year or more of the average daily net asset value of shares of
the money market fund acquired through this exchange program.
13
<PAGE>
The money market fund is not an FPA Fund and is separately managed. The fact
that you have the ability to exchange your shares for shares of the money market
fund is not a Fund recommendation of the money market fund.
HOW TO EXCHANGE YOUR SHARES. You can exercise your exchange privileges either
by written instructions or telephone (telephone exchange privileges are
available unless you specifically decline them on the account information form).
Exchanges are subject to the following restrictions:
- You are limited to four exchanges in one account during any calendar year;
if we give you notice you have exceeded this limit, any further exchanges
will be null and void;
- Shares must be owned 15 days before exchanging, and cannot be in
certificate form unless you deliver the certificate when you request the
exchange;
- An exchange requires the purchase of shares with a value of at least
$1,000; and
- Exchanges are subject to the same signature and signature guarantee
requirements applicable to the redemption of shares.
Exchanges and purchases are at the share price next determined after receipt of
a proper request (as described above under "Written Requests") by Boston
Financial Data Services, Inc. In the case of exchanges into the money market
fund, dividends generally start on the following business day.
For federal and state income tax purposes, an exchange is treated as a sale and
could result in a capital gain or loss. If the shares exchanged have been held
less than 91 days, the sales charge paid on them is not included in the tax
basis of the exchanged shares, but is carried over and included in the tax basis
of the shares acquired. See the Statement of Additional Information for further
information.
DISCONTINUATION OF THE EXCHANGE PROGRAMS. The Fund and FPA Fund
Distributors, Inc. can change or discontinue the rights to exchange Fund shares
into other FPA Funds or the money market fund upon 60 days' notice. If you have
exchanged your shares into shares of the money market fund, you will have at
least 60 days after being given notice of the end of the exchange program to
reacquire Fund shares without a sales charge.
FOR MORE INFORMATION OR FOR PROSPECTUSES FOR OTHER FPA FUNDS AND/OR THE MONEY
MARKET FUND, PLEASE CONTACT A DEALER OR FPA FUND DISTRIBUTORS, INC. YOU SHOULD
READ THE PROSPECTUSES OF THESE OTHER FUNDS AND CONSIDER DIFFERENCES IN
OBJECTIVES AND POLICIES BEFORE MAKING ANY EXCHANGE.
OTHER SHAREHOLDER SERVICES
INVESTMENT ACCOUNT. Each shareholder has an investment account in which Boston
Financial Data Services, Inc. holds Fund shares. You will receive a statement
showing account activity after each transaction. Unless you make a written
request, stock certificates will not be issued. Stock certificates are only
issued for full shares.
PRE-AUTHORIZED INVESTMENT PLAN. You may establish an account with a $100
minimum initial investment and the establishment of automatic monthly
investments. To make automatic monthly investments of at least $100, you must
complete the account information form available from dealers or FPA Fund
Distributors, Inc. Boston Financial Data Services, Inc. will withdraw funds from
your bank account monthly for $100 or more as specified through the Automated
Clearing House.
14
<PAGE>
RETIREMENT PLANS. If you are eligible, you can establish an IRA (individual
retirement account) and/or other retirement plan with a $100 minimum initial
investment and an expressed intention to increase the investment to $1,500
within 12 months. Each subsequent investment must be at least $100. Neither the
Fund nor FPA Fund Distributors, Inc. imposes additional fees for these plans,
but the plan custodian does.
You should consult your tax adviser about the implications of establishing a
retirement plan with Fund shares. Persons with earned income ineligible for
deductible contributions generally may make non-deductible contributions into an
IRA. The earnings on shares held in an IRA are generally tax-deferred. In
addition, the Taxpayer Relief Act of 1997 expanded opportunities for certain
investors to make deductible contributions to IRAs and also created two new
tax-favored accounts, the Roth IRA and the Education IRA, in which earnings
(subject to certain restrictions) are not taxed even on withdrawal. Tax matters
are complicated; you should consult your tax adviser. FPA Fund
Distributors, Inc. and dealers have applicable forms and information regarding
plan administration, custodial fees and other plan documents.
SYSTEMATIC WITHDRAWAL PLAN. If you have an account with a value of $10,000 or
more, you can make monthly, quarterly, semi-annual or annual withdrawals of $50
or more by electing this option on the account information form. Under this
arrangement, sufficient Fund shares will be sold to cover the withdrawals and
the proceeds will be forwarded to you as directed on the account information
form. Dividends and capital gains distributions are automatically reinvested in
the Fund at net asset value. If withdrawals continuously exceed reinvestments,
your account will be reduced and ultimately exhausted. Please note that
concurrent withdrawals and purchases are ordinarily not in your best interest
because of additional sales charges, and you will recognize any taxable gains or
losses on the automatic withdrawals.
DIVIDENDS, DISTRIBUTIONS AND TAXES
DIVIDENDS AND DISTRIBUTIONS
The Fund's investment income consists principally of dividends and interest
earned on its portfolio securities. This income, after payment of expenses, will
be distributed to you semi-annually. Net capital gains realized from the sale of
securities are distributed at least annually. Dividends and capital gain
distributions are automatically reinvested in the Fund at the share price
determined at the close of business the day after the record date, unless before
the record date for receipt of the dividend or capital gain distribution you
request cash payment of dividends and capital gains distributions. You can use
the account information form to request a cash payment.
TAX CONSEQUENCES
Dividends and capital gains are generally taxable whether they are reinvested or
received in cash -- unless you are exempt from taxation or entitled to tax
deferral. Dividends and distributions are taxed at ordinary rates while capital
gains may be taxed at a different rate. Furthermore, capital gains may be taxed
at different rates depending on the length of time the Fund holds its assets.
Redemptions from a retirement plan account and an ordinary shareholder account
could have different tax treatment.
15
<PAGE>
You must provide the Fund with a certified correct taxpayer identification
number (generally your social security number) and certify that you are not
subject to backup withholding. You can use the account information form for this
purpose. If you fail to do so, the IRS can require the Fund to withhold 31% of
your taxable distributions and redemptions. Federal law also requires the Fund
to withhold 30% or the applicable tax treaty rate from dividends paid to certain
nonresident aliens, non-U.S. partnership and non-U.S. corporation shareholder
accounts.
Federal tax law generally requires that a holder (such as the Fund) of a debt
security purchased at a discount (including a zero coupon security) accrue a
portion of the discount at which the security was purchased as income each year
even though the holder receives no interest payment in cash on the security
during the year. Periodic adjustments for inflation in the principal value of
inflation-indexed bonds also may give rise to original issue discount which is
includable in the Fund's gross income on a current basis. Similarly, the Fund
generally must recognize as income interest accrued on accrual bonds and other
debt securities even though not paid in cash. As an investment company, the Fund
must pay dividends equal to substantially all of its net investment income each
year. Since most shareholders reinvest dividends declared by the Fund, it is not
expected that cash dividend payments would exceed the total amount of cash
interest the Fund actually receives. Cash distributions are made from the cash
assets of the Fund or by liquidation of portfolio securities, if necessary. If
the principal value of an inflation-indexed bond is adjusted downward in any
period as a result of deflation, the reduction may be treated as a loss to the
extent the reduction exceeds coupon payments received in that period; in that
case, the amount distributable by the Fund may be reduced and amounts
distributed previously in the taxable year may be characterized in some
circumstances as return of capital.
Please see the Statement of Additional Information and consult with your tax
adviser.
16
<PAGE>
FINANCIAL HIGHLIGHTS
The financial highlights table is intended to help you understand the Fund's
financial performance for the past five years. Certain information reflects
financial results for a single Fund share. The total returns in the table
represent the rate that an investor would have earned or lost on an investment
in the Fund purchased at net asset value and assuming reinvestment of all
dividends and distributions. This information has been audited by Ernst & Young
LLP, whose report, along with the Fund's financial statements, are included in
the Statement of Additional Information, which is available upon request.
<TABLE>
<CAPTION>
FOR THE YEARS ENDED MARCH 31,
----------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Per share operating performance:
Net asset value at beginning of year............. $ 30.34 $ 38.30 $ 32.28 $ 27.55 $ 22.40
------- -------- ------- ------- -------
Income from investment operations:
Net investment income.......................... $ .12 $ .40 $ .49 $ .38 $ .33
Net realized and unrealized gain (loss) on
investment securities........................ 7.07 (4.76) 8.74 6.98 7.63
------- -------- ------- ------- -------
Total from investment operations................. $ 7.19 $ (4.36) $ 9.23 $ 7.36 $ 7.96
------- -------- ------- ------- -------
Less distributions:
Dividends from net investment income........... $ (.22) $ (.40) $ (.47) $ (.37) $ (.26)
Distributions from net realized capital
gains........................................ (4.03) (3.20) (2.74) (2.26) (2.55)
------- -------- ------- ------- -------
Total distributions.............................. $ (4.25) $ (3.60) $ (3.21) $ (2.63) $ (2.81)
------- -------- ------- ------- -------
Net asset value at end of year................... $ 33.28 $ 30.34 $ 38.30 $ 32.28 $ 27.55
======= ======== ======= ======= =======
Total investment return*......................... 25.39% (12.45)% 30.10% 27.30% 36.84%
Ratios/supplemental data:
Net assets at end of year (in $000's)............ 517,900 513,894 789,436 597,184 399,282
Ratio of expenses to average net assets.......... .86% .86% .83% .84% .87%
Ratio of net investment income to average net
assets.......................................... .35% 1.20% 1.38% 1.27% 1.28%
Portfolio turnover rate.......................... 18% 19% 24% 21% 21%
</TABLE>
------------
* Return is based on net asset value per share, adjusted for reinvestment of
distributions, and does not reflect deduction of the sales charge.
17
<PAGE>
- -
--- ---
<TABLE>
<S> <C> <C>
FOR SHAREHOLDER SERVICES CONTACT FOR RETIREMENT PLAN SERVICES FOR DEALER SERVICES CONTACT
BOSTON FINANCIAL DATA CALL YOUR EMPLOYER OR PLAN FPA FUND DISTRIBUTORS, INC.
SERVICES, INC. ADMINISTRATOR 11400 West Olympic Boulevard
P.O. Box 8115 FOR 24-HOUR INFORMATION GO TO Suite 1200
Boston, MA 02266-8115 FUNDMASTER MARKETING GROUP Los Angeles, CA 90064
(617) 483-5000 or INTERNET WEB SITE (310) 473-0225 or
(800) 638-3060 except Alaska http://www.fundmaster.com (800) 982-4372 except
Hawaii, Massachusetts and Alaska, Hawaii and
Puerto Rico Puerto Rico
</TABLE>
Telephone conversations may be recorded or monitored for verification, record
keeping and quality assurance purposes.
<TABLE>
<S> <C>
INVESTMENT ADVISER CUSTODIAN AND TRANSFER AGENT
FIRST PACIFIC ADVISORS, INC. STATE STREET BANK AND
11400 West Olympic Boulevard TRUST COMPANY
Suite 1200 225 Franklin Street
Los Angeles, CA 90064 Boston, MA 02110
</TABLE>
INQUIRIES CONCERNING TRANSFER OF REGISTRATION, DISTRIBUTIONS, REDEMPTIONS AND
SHAREHOLDER SERVICE SHOULD BE DIRECTED TO BOSTON FINANCIAL DATA SERVICES, INC.
INQUIRIES CONCERNING SALES SHOULD BE DIRECTED TO FPA FUND DISTRIBUTORS, INC.
MULTIPLE TRANSLATIONS
This Prospectus may be translated into other languages. If there are any
inconsistencies or ambiguities, the English text will prevail.
OTHER FUND INFORMATION
ANNUAL/SEMI-ANNUAL REPORT TO SHAREHOLDERS
Additional information about the Fund's investments is available in the Fund's
annual and semi-annual reports to shareholders. In the Fund's annual report, you
will find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year.
STATEMENT OF ADDITIONAL INFORMATION (SAI)
The SAI contains more detailed information on all aspects of the Fund, including
the Fund's financial statements.
A current SAI has been filed with the Securities and Exchange Commission ("SEC")
and is incorporated by reference into this Prospectus. The SAI and other related
materials about the Fund are available for review or to be copied at the SEC's
Public Reference Room in Washington, D.C. (1-202-942-8090) or from the EDGAR
database on the SEC's Internet Web Site at http://www.sec.gov and copies of this
information may be obtained, upon payment of a duplicating fee, by electronic
request at [email protected] or by writing the Reference Section of the SEC,
Washington, DC 20549-6009.
FOR MORE INFORMATION OR TO REQUEST A FREE COPY OF ANY OF THE DOCUMENTS ABOVE
CONTACT FPA FUND DISTRIBUTORS, INC. AT 11400 WEST OLYMPIC BOULEVARD,
SUITE 1200, LOS ANGELES, CALIFORNIA 90064, AT (800) 982-4372, EXCEPT FROM
ALASKA, HAWAII AND PUERTO RICO (WHERE YOU MAY CALL COLLECT (310) 473-0225).
Investment Company Act No. 811-1596
- -
--- ---
<PAGE>
STATEMENT OF ADDITIONAL INFORMATION
FPA CAPITAL FUND, INC.
August 1, 2000
This Statement of Additional Information supplements the current Prospectus of
FPA Capital Fund, Inc. ("Fund") dated August 1, 2000. This Statement does not
present a complete picture of the various topics discussed and should be read in
conjunction with the Fund's Prospectus. Although this Statement of Additional
Information is not itself a Prospectus, it is, in its entirety, incorporated by
reference into the Prospectus. The Fund's Prospectus can be obtained by
contacting your securities dealer or the Fund's principal underwriter, FPA Fund
Distributors, Inc. ("Distributor"), at 11400 West Olympic Boulevard, Suite 1200,
Los Angeles, California 90064; telephone (310) 473-0225 or (800) 982-4372,
except Alaska, Hawaii and Puerto Rico.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
<S> <C>
Investment Objective, Strategies and Policies.................................. 1
Description of Certain Securities and Investment Techniques.................... 1
Equity Securities......................................................... 1
Fixed-Income Securities................................................... 2
Inflation-Indexed Bonds................................................... 2
Mortgage-Backed Securities................................................ 3
Guaranteed Mortgage Pass-Through Securities............................... 3
Collateralized Mortgage Obligations, Multiclass Pass-Through Securities
and Accrual Certificates (Z-Bonds)...................................... 4
Stripped Mortgage-Backed Securities....................................... 5
Lower Rated Debt Securities .............................................. 6
Risk Factors Relating to Lower Rated Securities .......................... 7
Securities of Foreign Issuers............................................. 8
Covered Call Options...................................................... 8
Short Sales Against the Box............................................... 8
Repurchase Agreements..................................................... 9
Rule 144A and Other Restricted Securities................................. 9
Investment Restrictions........................................................ 9
Additional Restrictions................................................... 11
Fund Organization.............................................................. 11
Directors and Officers of the Fund............................................. 12
Five Percent Shareholders...................................................... 16
Management..................................................................... 17
Investment Adviser........................................................ 17
Investment Advisory and Service Agreement................................. 17
Principal Underwriter..................................................... 19
Portfolio Transactions and Brokerage........................................... 19
Portfolio Turnover............................................................. 20
Capital Stock.................................................................. 20
Common Stock.............................................................. 20
Voting Rights............................................................. 20
Purchase and Redemption of Shares.............................................. 20
Net Asset Value........................................................... 20
Sales Charges............................................................. 21
</TABLE>
-i-
<PAGE>
<TABLE>
<S> <C>
Authorized Financial Intermediaries....................................... 21
Sales at Net Asset Value.................................................. 21
Letter of Intent.......................................................... 21
FPA Exchange Privilege.................................................... 22
Redemption of Shares...................................................... 23
Telephone Redemption...................................................... 23
Tax Sheltered Retirement Plans................................................. 24
Dividends, Distributions and Taxes............................................. 24
Distributor.................................................................... 25
Prior Performance Information.................................................. 26
Financial Statements........................................................... 28
</TABLE>
ii
<PAGE>
INVESTMENT OBJECTIVE, STRATEGIES AND POLICIES
The following limitations and guidelines are considered at the time of purchase,
under normal market conditions, and are based on a percentage of FPA Capital
Fund, Inc.'s (the "Fund") net assets unless otherwise noted. This summary is not
intended to reflect all of the Fund's investment limitations.
INVESTMENT OBJECTIVE AND STRATEGIES
- The Fund's primary objective is long-term growth of capital. Providing
you current income is a secondary consideration. The Adviser believes
that the Fund's goals can best be achieved by investing primarily in
common stocks the Adviser deems to possess above-average ability to
increase in market value. The Fund may also invest in United States
Government and government agency obligations, corporate debt
securities, preferred stocks and convertible securities. Up to 15% of
the Fund's net assets may be invested in lower-rated or comparable
unrated debt securities.
- Investments in the Fund are not limited by a specific industry, and
substantially all common stocks purchased by the Fund will be listed on
a national securities exchange or the National Association of
Securities Dealers Automated Quotation (NASDAQ) National Market System
or National List.
FIXED-INCOME SECURITIES
- Up to 15% of the Fund's net assets can be invested in fixed-income
securities, including convertible securities, that are rated BB or
lower, by Standard & Poor's Corporation or Ba or lower by Moody's
Investor Services, Inc.
- The Fund can invest in inflation-indexed bonds which are fixed-income
securities whose principal value is periodically adjusted to reflect
the rate of inflation.
- The Fund can invest in mortgage-backed securities which represent an
interest in a pool of mortgage loans. Collateralized mortgage
obligations are a type of bond secured by an underlying pool of
mortgages or mortgage pass-through certificates that are structured to
direct payments on underlying collateral to different series or classes
of the obligations. A variety of CMO certificates may be issued in
sequential pay structures. These securities include accrual
certificates (also known as "Z-bonds") which only accrue interest at a
specified rate until all other certificates having an earlier final
distribution date have been retired and are converted thereafter to an
interest-paying security. Up to 5% of the Fund's assets can be invested
in interest-only classes of stripped mortgage-backed securities.
NON-U.S. SECURITIES
- The Fund can invest up to 10% of its net assets in securities of
foreign issuers.
DESCRIPTION OF CERTAIN SECURITIES AND INVESTMENT TECHNIQUES
EQUITY SECURITIES -- The Fund will invest primarily in equity securities. Equity
securities represent an ownership position in a company. The prices of equity
securities fluctuate based on changes in the financial conditions of their
issuers and on market and economic conditions. These fluctuations can be
1
<PAGE>
severe and can generate large losses.
FIXED-INCOME SECURITIES -- The Fund can invest in fixed-income securities. Bonds
and other fixed-income securities are used by issuers to borrow money. Issuers
pay investors interest and generally must repay the amount borrowed at maturity.
Some fixed-income securities, such as zero coupon bonds, do not pay current
interest but are purchased at a discount from their face value. The market price
of fixed-income securities held by the Fund can be expected to vary inversely to
changes in prevailing interest rates and can also be affected by the financial
conditions of the issuers. Investments in fixed-income securities with longer
maturities generally produce higher yields but are subject to greater market
fluctuation.
INFLATION-INDEXED BONDS -- The Fund can invest in inflation-indexed bonds which
are fixed-income securities whose principal value is periodically adjusted to
reflect the rate of inflation. Such bonds generally are issued at an interest
rate lower than comparable non-indexed bonds, but are expected to retain their
principal value over time. The interest rate on these bonds is fixed at
issuance, but over the life of the bond this interest may be paid on an
increasing principal value, which has been adjusted for inflation.
Inflation-indexed bonds issued by the U.S. Treasury have maturities of five,
ten, and thirty years, although it is anticipated that securities with other
maturities will be issued in the future. If the periodic adjustment rate
measuring inflation falls, the principal value of inflation-indexed bonds will
be adjusted downward, and consequently the interest payable on these securities
(calculated with respect to a smaller principal amount) will be reduced.
Repayment of the original bond principal upon maturity (as adjusted for
inflation) is guaranteed in the case of U.S. Treasury inflation-indexed bonds,
even during a period of deflation. However, the current market value of the
bonds is not guaranteed, and will fluctuate. Any increase in the principal
amount of an inflation-indexed bond is considered taxable ordinary income, even
though investors do not receive their principal until maturity. See also
"Dividends, Distributions and Taxes" in the Prospectus.
Inflation-indexed bonds issued by the U.S. Treasury pay interest on a
semi-annual basis, equal to a fixed percentage of the inflation-adjusted
principal amount. For example, if a Fund purchased an inflation-indexed bond
with a par value of $1,000 and a 3% real rate of return coupon (payable 1.5%
semi-annually), and inflation over the first six months were 1%, the mid-year
par value of the bond would be $1,010 and the first semi-annual interest payment
would be $15.15 ($1,010 times 1.5%). If inflation continued during the second
half of the year and reached 3% by year end, the end-of-year par value of the
bond would be $1,030 and the second semi-annual interest payment would be $15.45
($1,030 times 1.5%).
The value of inflation-indexed bonds is expected to change in response to
changes in real interest rates. Real interest rates in turn are tied to the
relationship between nominal interest rates and the rate of inflation.
Therefore, if inflation were to rise at a faster rate than nominal interest
rates, real interest rates might decline, leading to an increase in the value of
inflation-indexed bonds. In contrast, if nominal interest rates increased at a
faster rate than inflation, real interest rates might rise, leading to a
decrease in the value of inflation-indexed bonds.
While these securities are expected to be protected from long-term inflationary
trends, short-term increases in inflation may lead to a decline in value. If
interest rates rise due to reasons other than inflation (for example, due to
changes in currency exchange rates), investors in these securities may not be
protected to the extent that the increase is not reflected in the bond's
inflation measure.
The periodic adjustment of U.S. inflation-indexed bonds is tied to the Consumer
Price Index for Urban Consumers ("CPI-U"), which is calculated monthly by the
U.S. Bureau of Labor Statistics. The CPI-U is
2
<PAGE>
a measurement of changes in the cost of living, made up of components such as
housing, food, transportation and energy. There can be no assurance that the
CPI-U will accurately measure the real rate of inflation in the prices of goods
and services.
MORTGAGE-BACKED SECURITIES -- The Fund can invest in mortgage-backed securities
which represent an interest in a pool of mortgage loans. The primary issuers or
guarantors of mortgage-backed securities are the Government National Mortgage
Association ("GNMA"), the Federal National Mortgage Association ("FNMA"), and
the Federal Home Loan Mortgage Corporation ("FHLMC") (securities issued by GNMA,
but not those issued by FNMA or FHLMC, are backed by the "full faith and credit"
of the United States). Mortgage-backed securities are also issued by certain
private, nongovernmental corporations, such as financial institutions.
Mortgage-backed securities provide a monthly payment consisting of interest and
principal payments. Additional payments may be made out of unscheduled
repayments of principal resulting from the sale of the underlying residential
property, refinancing or foreclosure, net of fees or costs that may be incurred.
Prepayments of principal on mortgage-related securities may tend to increase due
to refinancing of mortgages as interest rates decline. Prompt payment of
principal and interest on GNMA mortgage pass-through certificates is backed by
the full faith and credit of the United States. FNMA guaranteed mortgage
pass-through certificates and FHLMC participation certificates are solely the
obligations of those entities but are supported by the discretionary authority
of the U.S. Government to purchase the agencies' obligations. To the extent that
the Fund purchases mortgage-backed securities at a premium, prepayments may
result in some loss of the Fund's principal investment to the extent of the
premium paid. In addition, like other debt securities, the value of
mortgage-related securities will generally fluctuate in response to market
interest rates.
The mortgage-backed securities in which the Fund may invest may include those
backed by the full faith and credit of the United States. GNMA, the principal
U.S. guarantor of such securities, is a wholly owned U.S. Government corporation
within the Department of Housing and Urban Development. The Fund may also invest
in government-related mortgage-backed securities which are not backed by the
full faith and credit of the United States such as those issued by FNMA and
FHLMC. Pass-through securities issued by FNMA are guaranteed as to timely
payment of principal and interest by FNMA. Participation certificates
representing interests in mortgages from FHLMC's national portfolio are
guaranteed as to the timely payment of interest and ultimate collection of
principal by FHLMC. The Fund may also invest in mortgage-backed securities
issued by private non-governmental corporations, such as financial institutions.
The average maturity of pass-through pools of mortgage-backed securities varies
with the maturities of the underlying mortgage instruments. In addition, a
pool's stated maturity may be shortened by unscheduled payments on the
underlying mortgages. Factors affecting mortgage prepayments include the level
of interest rates, general economic and social conditions, the location of the
mortgaged property and the age of the mortgage. Because prepayment rates of
individual mortgage pools vary widely, it is not possible to accurately predict
the average life of a particular pool. Common industry practice, for example, is
to assume that prepayments will result in a 7- to 9-year average life for pools
of fixed-rate 30-year mortgages. Pools of mortgages with other maturities of
different characteristics will have varying average life assumptions.
GUARANTEED MORTGAGE PASS-THROUGH SECURITIES -- The Fund can invest in mortgage
pass-through securities representing participation interests in pools of
residential mortgage loans originated by United
3
<PAGE>
States governmental or private lenders and guaranteed, to the extent provided in
such securities, by a Federal Agency. 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 semiannually) and principal payments at maturity or on specified dates.
Mortgage pass-through securities provide for monthly payments (not necessarily
in fixed amounts) 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 the Fund may invest
include those issued or guaranteed by GNMA, FNMA and FHLMC. GNMA certificates
are direct obligations of the U.S. Government and, as such, are backed by the
"full faith and credit" of the United States. FNMA and FHLMC are federally
chartered, privately owned corporations which are instrumentalities of the
United States. FNMA and FHLMC certificates are not backed by the full faith and
credit of the United States.
Certificates for these types of mortgage-backed securities evidence an interest
in a specific pool of mortgages. These certificates are, in most cases,
"modified pass-through" instruments, under which the issuing agency guarantees
the payment of principal and interest on mortgages underlying the certificates,
whether or not such amounts are collected by the issuer on the underlying
mortgages.
COLLATERALIZED MORTGAGE OBLIGATIONS, MULTICLASS PASS-THROUGH SECURITIES AND
ACCRUAL CERTIFICATES (Z BONDS) -- Collateralized mortgage obligations ("CMOs")
are a type of bond secured by an underlying pool of mortgages or mortgage
pass-through certificates that are structured to direct payments on underlying
collateral to different series or classes of the obligations. CMOs issue a
series of bonds or certificates in multiple classes. Each class, often referred
to as a "tranche," is issued at a specific fixed or floating coupon rate and has
a stated maturity or final distribution date. Interest is paid or accrues on all
classes of the CMOs on a monthly, quarterly or semi-annual basis. Principal
prepayments on the underlying pool of mortgages may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Changes in estimated prepayment rates alter the expected life of mortgage-backed
securities. In periods of sharp interest rate movements and/or in periods of
supply and demand imbalances in the market for such securities, the prices of
certain CMOs may fluctuate to a greater extent than would be expected from
interest rate movements alone. For example, an increase in interest rates would
not only likely decrease the value of CMOs owned by the Fund but would also
increase the inherent volatility of the Fund by effectively lengthening the
expected life of these securities.
A variety of CMO certificates may be issued in sequential pay structures. These
securities include accrual certificates (also known as "Z-bonds") which only
accrue interest at a specified rate until all other certificates having an
earlier final distribution date have been retired and are converted thereafter
to an interest-paying security. The market prices of CMOs structured as accrual
bonds are affected to a greater extent by interest rate changes and therefore
tend to be more volatile than securities which pay interest periodically and in
cash.
The Fund may invest in CMOs which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. Typically, CMOs are
collateralized by GNMA, FNMA or FHLMC certificates, but also may be
collateralized by whole loans or private mortgage pass-through securities (such
collateral is collectively hereinafter referred to as "Mortgage Assets").
Multiclass pass-through securities are equity interests in a trust composed of
Mortgage
4
<PAGE>
Assets. 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 distributions on the multiclass pass-through securities. CMOs
may be issued by Federal Agencies, or by private originators of, or investors
in, mortgage loans, including savings and loan associations, mortgage banks,
commercial banks, investment banks and special purpose subsidiaries of the
foregoing. The issuer of a series of CMOs may elect to be treated as a Real
Estate Mortgage Investment Conduit ("REMIC"). REMICs include governmental and/or
private entities that issue a fixed pool of mortgages secured by an interest in
real property. REMICs are similar to CMOs in that they issue multiple classes of
securities, but unlike CMOs, which are required to be structured as debt
securities, REMICs may be structured as indirect ownership interests in the
underlying assets of the REMICs themselves. However, the Fund's investment in a
CMO is not effected by the issuer's election to be treated as a REMIC, and all
future references to CMOs shall also be deemed to include REMICs.
In CMOs, a series of bonds or certificates is issued in multiple classes. Each
class of CMOs, often referred to as a "tranche," is issued at a specific fixed
or floating coupon rate and has a stated maturity or final distribution date.
Principal prepayments on the Mortgage Assets may cause the CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrues on all classes of the CMOs on a monthly, quarterly
or semiannual basis. Certain CMOs may have variable or floating interest rates
and others may be Stripped Mortgage Securities.
The principal of and interest on the Mortgage Assets may be allocated among the
several classes of a CMO series in a number of different ways. Generally, the
purpose of the allocation of the cash flow of a CMO to the various classes is to
obtain a more predictable cash flow to certain of the individual tranches than
exists with the underlying collateral of the CMO. As a general rule, the more
predictable the cash flow is on a CMO tranche, the lower the anticipated yield
will be on that tranche at the time of issuance relative to prevailing market
yields on other mortgage-backed securities. As part of the process of creating
more predictable cash flows on most of the tranches in a series of CMOs, one or
more tranches generally must be created that absorb most of the volatility in
the cash flows on the underlying mortgage loans. The yields on these tranches
are generally higher than prevailing market yields on mortgage-backed securities
with similar maturities. As a result of the uncertainty of the cash flows of
these tranches, the market prices of and yield on these tranches generally are
more volatile.
STRIPPED MORTGAGE-BACKED SECURITIES -- The Fund can invest in stripped
mortgage-backed securities. Up to 5% of the Fund's net assets can be invested in
interest-only classes of stripped mortgage-backed securities. The prices of
these securities are likely to be volatile in the event of changes in mortgage
prepayment rates, or expectations related thereto. In addition, these securities
tend to be less liquid than other CMOs.
Stripped mortgage-backed securities represent beneficial ownership interests in
either periodic principal distributions (the principal-only or "PO" class) or
interest distributions (the interest-only or "IO" class) on mortgage-backed
certificates. The certificates underlying the stripped mortgage-backed
securities represent all or part of the beneficial interest in pools of
fixed-rate Mortgage Assets. The Fund may invest in IO securities in order to
enhance yield or to benefit from anticipated appreciation in value of the
securities at times when the Adviser believes that interest rates will remain
stable or increase. In periods of rising interest rates, the value of IO
securities may be expected to increase because of the diminished expectation
that the underlying mortgages will be prepaid. In this situation, the expected
increase in the value of IO securities may offset all or a portion of any
decline in value of other debt securities owned by the Fund. Investing in
stripped mortgage-backed securities involves the risks normally associated with
investing in
5
<PAGE>
mortgage-backed securities. In addition, the yields on IO and PO securities are
extremely sensitive to the prepayment experience on the mortgage loans
underlying the certificates collateralizing the securities. If a decline in the
level of prevailing interest rates results in a rate of principal prepayments
higher than anticipated, distributions of principal will be accelerated, thereby
reducing the yield to maturity on IO securities and increasing the yield to
maturity on PO securities. Conversely, if an increase in the level of prevailing
interest rates results in a rate of principal prepayments lower than
anticipated, distributions of principal will be deferred, thereby increasing the
yield to maturity on IO securities and decreasing the yield to maturity on PO
securities. Sufficiently high prepayments rates could result in the Fund's not
fully recovering its initial investment in an IO security. There can be no
assurance that the Fund will be able to effect a trade of a stripped
mortgage-backed security at a time when it wishes to do so. Stripped
mortgage-backed securities will be considered illiquid securities unless (i)
issued by the United States Government or an agency or instrumentality thereof,
(ii) backed by fixed-rate mortgages, and (iii) there appears to be a liquid
secondary market for the security.
LOWER RATED DEBT SECURITIES -- The Fund can invest up to 15% of its net assets
in fixed-income securities, including convertible securities, which are rated BB
or lower, by Standard & Poor's Corporation ("S&P") or Ba or lower by Moody's
Investor Services, Inc. ("Moody's"), which ratings are considered by the rating
agencies to be speculative, and unrated securities considered by the Adviser to
be of comparable quality. Debt securities with a rating of BB/Ba or lower are
commonly referred to as "junk bonds."
To the extent the Fund acquires convertible securities or other debt securities
that are rated lower than investment grade or are not rated, there is a greater
risk that payment of principal and interest will not be made on a timely basis
or at all. Decisions to purchase and sell these securities are based on the
Adviser's evaluation of their investment potential and not on the ratings
assigned by credit agencies. Because investment in lower-rated securities
involves greater investment risk, achievement of the Fund's investment objective
depends more on the Adviser's credit analysis than it does with respect to the
Fund's investments in higher-rated securities. Lower-rated securities may be
more susceptible to real or perceived adverse economic and competitive industry
conditions than investment grade securities. A projection of an economic
downturn, for example, could cause a decline in the prices of lower-rated
securities because the advent of a recession could lessen the ability of a
highly leveraged company to make principal and interest payments on its debt
securities. In addition, the secondary trading market for lower-rated securities
may be less liquid than the market for higher-rated securities.
Prices of lower-rated securities may decline rapidly if many holders decide to
sell. Changes in expectations regarding an individual issuer, an industry or
lower-rated securities generally could reduce market liquidity for such
securities and make it harder to sell them. The lower-rated bond market has
grown primarily during a period of long economic expansion, and it is uncertain
how it would perform during an extended economic downturn. An economic downturn
or an increase in interest rates could severely disrupt the market for
lower-rated bonds and adversely affect the value of outstanding bonds and the
ability of the issuers to repay principal and interest.
The lower-rated securities in which the Fund can invest include debt securities
of companies that are financially troubled, in default or are in bankruptcy or
reorganization ("Deep Discount Securities"). These securities could be rated C,
C1 or D by S&P or C by Moody's or may be unrated. Debt obligations of such
companies are usually available at a deep discount from the face value of the
instrument. The Fund may invest in Deep Discount Securities when the Adviser
believes that existing factors are likely to
6
<PAGE>
improve the company's financial condition. These factors include a restructuring
of debt, management changes, existence of adequate assets, or other special
circumstances.
A debt instrument purchased at a deep discount, but before default, may
currently pay a very high effective yield. In addition, if the financial
condition of the issuer improves, the underlying value of the securities could
increase, resulting in a capital gain. If the issuer defaults on its obligations
or remains in default, or if the plan of reorganization is insufficient for
debt-holders, the Deep Discount Securities could stop generating income and lose
value or become worthless. The Adviser will balance the benefits of Deep
Discount Securities with their risks. While a diversified portfolio may reduce
the overall impact of a Deep Discount Security that is in default or loses its
value, the risk cannot be eliminated.
As of March 31, 2000, none of the Fund's net assets were invested in convertible
securities, 5.5% of the Fund's net assets were invested in non-convertible bonds
and debentures (of which 90.8% represent U.S. Government and agency securities),
and 2.3% of the Fund's net assets were held in high grade short-term
investments.
RISK FACTORS RELATING TO LOWER RATED SECURITIES
1. SENSITIVITY TO INTEREST RATE AND ECONOMIC CHANGES. The economy and interest
rates affect high yield securities differently from other securities. The
prices of high yield bonds have been found to be less sensitive to interest
rate changes than higher rated investments, but more sensitive to adverse
economic changes or individual issuer developments. During an economic
downturn or substantial period of rising interest rates, highly leveraged
issuers are likely to experience financial stress which would adversely
affect their ability to service their principal and interest payment
obligations, to meet projected business goals, and to obtain additional
financing. If the issuer of a bond owned by the Fund defaults, the Fund may
incur additional expenses to seek recovery. In addition, periods of
economic uncertainty and changes can be expected to result in increased
volatility of market prices of high yield bonds and the Fund's asset value.
Furthermore, the market prices of high yield bonds structured as zero
coupon or pay-in-kind securities are affected to a greater extent by
interest rate changes and thereby tend to be more volatile than securities
that pay interest periodically and in cash.
2. LIQUIDITY AND VALUATION. To the extent that there is no established retail
secondary market, there may be thin trading of high yield bonds, and there
could be a negative impact on the Fund's Board of Directors' ability to
accurately value high yield bonds and the Fund's assets and on the Fund's
ability to dispose of the bonds. Adverse publicity and investor
perceptions, whether or not based on fundamental analysis, can decrease the
values and liquidity of high yield bonds, especially in a thinly traded
market. To the extent the Fund owns or may acquire illiquid high yield
bonds, these securities may involve special liquidity and valuation
difficulties.
3. LEGISLATION. New laws and proposed new laws could have a negative impact on
the market for high yield bonds. For example, several years ago legislation
required federally-insured savings and loan associations to divest their
investments in high yield bonds.
4. TAXATION. Special tax considerations are associated with investing in high
yield bonds structured as zero coupon or pay-in-kind securities. The Fund
accrues the interest on these securities as income
7
<PAGE>
even though it receives no cash interest until the security's maturity or
payment date. The Fund is required to distribute such income to its
shareholders in order to maintain its qualification for pass-through
treatment under the Internal Revenue Code. Thus, the Fund may have to
dispose of portfolio securities at a time it otherwise might not want to do
so in order to provide the cash necessary to make distributions to those
shareholders who do not reinvest dividends.
5. CREDIT RATINGS. Certain risks are associated with applying credit ratings
as a method of evaluating high yield bonds. Credit ratings evaluate the
safety of principal and interest payments, not market value risk, of high
yield bonds. Since credit rating agencies may fail to timely change the
credit ratings to reflect subsequent events, the Adviser monitors the
issuers of high yield bonds in the Fund's portfolio to determine if the
issuers appear to have sufficient cash flow to meet required principal and
interest payments. The Fund may retain a portfolio security whose rating
has been changed.
SECURITIES OF FOREIGN ISSUERS -- The Fund can invest up to 10% of its net assets
in securities of foreign issuers. Investments in securities of foreign issuers
can be affected favorably or unfavorably by changes in currency rates and
exchange control regulations. Compared to U.S. companies, there might be less
publicly available information about foreign companies, which generally are
subject to less stringent accounting, auditing and financial reporting standards
and requirements. Securities of some foreign companies might be less liquid or
more volatile than those of U.S. companies. Foreign brokerage commissions and
custodial fees are generally higher than in the United States. Settlement of
transactions in some foreign markets can be delayed or can be less frequent than
in the U.S., which could affect the liquidity of the Fund's portfolio.
Investments in foreign securities can involve additional risks, including local
political or economic developments, expropriation or nationalization of assets
and imposition of withholding taxes on dividend or interest payments. In the
event of a default on any foreign debt obligation, it could be more difficult
for the Fund to obtain or enforce a judgment against the issuer.
COVERED CALL OPTIONS -- In an effort to increase potential income, the Fund is
authorized to write (i.e. sell) covered call options listed on a national
securities exchange. When the Fund writes a listed call option, the purchaser
has the right to buy a security from the Fund at a fixed exercise price any time
before the option contract expires, regardless of changes in the market price of
the underlying security. The Fund writes options only on securities it owns
(covered options) and must retain ownership of the underlying security while the
option is outstanding. Until the option expires, the Fund cannot profit from a
rise in the market price of the underlying security over the exercise price,
except insofar as the premium which the Fund receives, net of commissions,
represents a profit. The premium paid to the Fund is the consideration for
undertaking this obligation.
The Fund may not write any option which, at the time, would cause its
outstanding options to cover securities comprising more than 10% of its asset
value. Writing option contracts is a highly specialized activity and could limit
investment flexibility at certain times. The maximum term for listed options
exceeds two years, but the Fund expects that most options it writes will not
exceed six months.
SHORT SALES AGAINST THE BOX -- The Fund can make short sales of securities or
maintain a short position if the Fund contemporaneously owns or has the right to
obtain at no added cost identical securities to those sold short (short sales
"against the box") or if the securities sold are "when issued" or "when
distributed" securities that the Fund expects to receive in a recapitalization,
reorganization, or other exchange for securities the Fund contemporaneously owns
or has the right to obtain at no added cost. The principal
8
<PAGE>
purpose of short sales is to enable the Fund to obtain the current market price
of a security that the Fund desires to sell but which cannot be currently
delivered for settlement. The Fund will not make short sales or maintain a short
position if to do so would cause more than 25% of its total net assets
(exclusive of proceeds from short sales) to be allocated to a segregated account
in connection with short sales.
The Fund did not effect any short sales in the last fiscal year.
REPURCHASE AGREEMENTS -- The Fund can invest up to 20% of its total assets in
repurchase agreements with domestic banks or dealers to earn interest on
temporarily available cash. A repurchase agreement is a short-term investment in
which the purchaser (i.e., the Fund) acquires a debt security that the seller
agrees to repurchase at a future time and set price, thereby determining the
yield during the holding period. Repurchase agreements are collateralized by the
underlying debt securities and may be considered loans under the Investment
Company Act of 1940 ("Investment Company Act"). In the event of bankruptcy or
other default by the seller, the Fund could experience delays and expenses
liquidating the underlying security, loss from decline in value of such
security, and lack of access to income on such security. The Fund will not
invest more than 10% of its total assets in repurchase agreements that mature in
more than seven days and/or other securities which are not readily marketable.
RULE 144A AND OTHER RESTRICTED SECURITIES -- The Fund can invest up to 5% of its
net assets in Rule 144A securities or other securities subject to legal or
contractual restrictions on resale.
Rule 144A was adopted under the Securities Act of 1933 (the "1933 Act") to allow
a broader institutional trading market for securities subject to restriction on
resale to the general public. The Rule provides a "safe harbor" for the resale
of certain restricted securities among qualified institutional investors without
registration under the 1933 Act. Other securities subject to legal or
contractual restrictions on resale generally may be resold only in a privately
negotiated transaction with a limited number of purchasers or in a public
offering registered under the 1933 Act. Considerable delay could be encountered
in either event. These difficulties and delays could result in the Fund's
inability to realize a favorable price upon disposition of restricted
securities, and in some cases may make disposition of such restricted securities
at the time desired by the Fund impossible.
INVESTMENT RESTRICTIONS
The Fund has adopted the investment restrictions stated below. They apply at the
time securities are purchased or other relevant action is taken. These
restrictions and the Fund's investment objectives cannot be changed without
approval of the holders of a majority of outstanding Fund shares. The Investment
Company Act defines this majority as the lesser of (a) 67% or more of the voting
securities present in person or represented by proxy at a meeting, if the
holders of more than 50% of the outstanding voting securities are present or
represented by proxy; or (b) more than 50% of the outstanding voting securities.
In addition to those described in the Prospectus, these restrictions provide
that the Fund will not:
1. Borrow any amount other than as a temporary measure for extraordinary or
emergency purposes as determined by the Fund's Board of Directors;
2. Concentrate more than 25% of the value of its assets in a particular
industry;
9
<PAGE>
3. Purchase the securities of any one issuer (except securities issued by the
United States of America, or any instrumentality thereof) if the holdings
of the Fund in the securities of such issuer exceed 5% of the market value
of the Fund's total assets;
4. Purchase the securities of any one issuer causing the Fund's holdings to
exceed 10% of the outstanding voting securities of such issuer or 10% of
any class of securities of such issuer.
5. Issue any class of senior security nor sell any senior security of which it
is the issuer, except that the Fund is permitted to borrow from any bank;
provided that such borrowing may only be as a temporary measure for
extraordinary or emergency purposes, but not for investment purposes and
shall not, in the aggregate, exceed 10% of its total assets taken at cost
or 5% of its total assets taken at current value, whichever is less; and
provided that immediately after such borrowing, there is an asset coverage
of at least 300% for all borrowings of the Fund;
6. Underwrite the sale of any securities other than Fund shares;
7. Purchase or sell commodities, commodity contracts or real estate;
8. Lend money or securities to any person, firm, or corporation for any
purpose whatsoever; provided, however, that the following are not construed
as the making of a loan: (a) the acquisition of a portion of publicly
distributed bonds, debentures, notes and other obligations or evidence of
interest in or indebtedness of any corporation, domestic or foreign, or of
any government or municipality; (b) the acquisition of obligations of, or
obligations guaranteed by, national or state banks or bank holding
companies (including certificates of deposit and bankers acceptances); and
(c) the entry into repurchase agreements if the following conditions are
met: (1) that the securities or instruments subject to the agreement are of
the type in which the Fund may otherwise invest, (2) that at the time the
repurchase agreement is made the value of the securities or instruments
involved is equal to the purchase price, (3) that not more than 20% of the
Fund's total assets, at the time the agreement is made, will be invested
pursuant to such agreements, and (4) that such agreements with any one
entity, together with any other investments in that entity, shall not
exceed in the aggregate 5% of the Fund's total assets, at market value,
computed at the time the agreement is made;
9. Mortgage, pledge, hypothecate or in any manner transfer, as security for
any indebtedness, any security owned or held by the Fund;
10. Participate on a joint or a joint and several basis in any trading account
in securities;
11. Purchase from or sell to any officer or director of the Fund, or firms of
which any of them are members, any securities other than Fund shares; but
such persons or firms may act as brokers for the Fund for customary
commissions;
12. Purchase or retain any securities of any issuer if those officers and
directors of the Fund or of its manager or investment adviser owning
individually more than 0.5% of the securities of such issuer together own
beneficially more than 5% of the securities of such issuer;
13. Invest for the purpose of exercising control over or management of any
company;
10
<PAGE>
14. Invest in securities issued by other investment companies;
15. Effect short sales of securities, except that the Fund may make certain
short sales of securities or maintain a short position if the Fund
contemporaneously owns or has the right to obtain at no added cost
securities identical to those sold short (short sales "against the box") or
if the securities sold are "when issued" or "when distributed" securities
which the Fund expects to receive in a recapitalization, reorganization, or
other exchange for securities the Fund contemporaneously owns or has the
right to obtain at no added cost;
16. Buy securities on margin;
17. Purchase or sell securities other than Fund shares through any brokerage or
investment organization in which any officer or director of the Fund is a
partner, officer, director or shareholder;
18. Invest more than 5% of its assets in securities of corporations which have
a record of less than three years continuous operation; or
19. Write options, except the Fund may write covered call options and effect
closing transactions; provided the Fund shall: (i) write options only on
securities which it owns and which are traded on a national securities
exchange; (ii) retain ownership of the underlying security for the duration
of said options and (iii) not write any option which would, at the time,
cause outstanding options written by the Fund to cover securities
comprising more than 10% of the value of the Fund's assets.
ADDITIONAL RESTRICTIONS. The Fund is also subject to the following policies
which its Board of Directors can amend and which apply at the time of purchase
of securities. The Fund will not:
1. Invest more than 10% of total assets in repurchase agreements with
maturities over seven days and/or other securities which are not readily
marketable;
2. Purchase warrants exceeding 2% of total assets;
3. Invest in oil, gas or other mineral exploration or development programs; or
4. Purchase Rule 144A securities in an amount exceeding 5% of the Fund's net
assets or purchase other securities subject to legal or contractual
restrictions on resale in an amount exceeding 5% of the Fund's net assets.
FUND ORGANIZATION
The Fund is a Maryland corporation and a diversified, open-end management
investment company, generally called a mutual fund, which was organized in 1966.
A mutual fund provides the investor a practical and convenient way to invest in
a diversified portfolio of securities by combining resources with others who
have similar investment goals.
A board of four directors is responsible for overseeing the Fund's affairs.
11
<PAGE>
DIRECTORS AND OFFICERS OF THE FUND
All directors and officers of the Fund are also directors and/or officers of one
or more of four other investment companies advised by the Adviser, which is an
indirect wholly owned subsidiary of United Asset Management Corporation ("UAM").
These investment companies are FPA New Income, Inc., FPA Paramount Fund, Inc.,
FPA Perennial Fund, Inc. and Source Capital, Inc. (collectively, the "FPA Fund
Complex").
The directors and officers of the Fund, their ages on the date hereof and their
principal occupations during the past five years follow. Their address is 11400
West Olympic Boulevard, Suite 1200, Los Angeles, California 90064.
12
<PAGE>
FUND DIRECTORS AND OFFICERS
DIRECTORS
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1)
COMPENSATION (1) FROM THE FPA TOTAL NUMBER OF
FROM THE FUND COMPLEX BOARDS OF FUNDS
FUND DURING DURING THE FISCAL MANAGED BY THE
POSITION HELD PRINCIPAL OCCUPATION(S) THE FISCAL YEAR YEAR ENDED ADVISER ON WHICH
NAME/AGE WITH FUND DURING PAST 5 YEARS ENDED 3/31/00 3/31/00 DIRECTOR SERVED
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Willard H. Altman, 64 Director Former Partner of Ernst & Young $10,000 $43,000 4
LLP, independent auditors for
the Fund. Director of Source
Capital, Inc. (since May 1998),
of FPA New Income, Inc. (since
July 1998) and of FPA Perennial
Fund, Inc. (since August 1998).
Director of Current Income
Shares, Inc., a closed-end
investment company. Vice
President of Evangelical Council
for Financial Accountability,
an accreditation organization
for Christian non-profit
entities.
-----------------------------------------------------------------------------------------------------------------------------------
Donald E. Cantlay, 77 Director $ 584 $ 1,168 2
(Until 5/99)
-----------------------------------------------------------------------------------------------------------------------------------
DeWayne W. Moore, 86 Director Former Director, Senior Vice $10,000 $20,000 2
President and Chief Financial
Officer of Guy F. Atkinson
Company of California
(construction). Director of FPA
New Income, Inc. for more than
the past five years.
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
AGGREGATE
AGGREGATE COMPENSATION (1)
COMPENSATION (1) FROM THE FPA TOTAL NUMBER OF
FROM THE FUND COMPLEX BOARDS OF FUNDS
FUND DURING DURING THE FISCAL MANAGED BY THE
POSITION HELD PRINCIPAL OCCUPATION(S) THE FISCAL YEAR YEAR ENDED ADVISER ON WHICH
NAME/AGE WITH FUND DURING PAST 5 YEARS ENDED 3/31/00 3/31/00 DIRECTOR SERVED
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Alfred E. Osborne, Jr., 55 Director Director of the Harold Price $ 2,696 $ 5,392 2
(Elected Center for Entrepreneurial
12/20/99) Studies and Associate Professor
of Business Economics at The
John E. Anderson Graduate School
of Management at UCLA, Dr.
Osborne has been at UCLA since
1972, Director of FPA New
Income, Inc. (since December
1999), of K2 Inc., of Nordstrom,
Inc., and of E* Capital
Corporation, a privately held
company, which operates a
venture capital fund and owns
Wedbush Morgan Securities, Inc.,
a broker-dealer. Independent
general partner of Technology
Funding Venture Partners V L.P.,
a business development company.
Trustee of the WM Group of
Funds, a mutual fund complex.
-----------------------------------------------------------------------------------------------------------------------------------
Lawrence J. Sheehan, 68* Director Of counsel to, and partner $10,000 $43,000 4
(1969 to 1994) of, the law firm
of O'Melveny & Myers LLP, legal
counsel to the Fund. Director of
Source Capital, Inc., of FPA
Perennial Fund, Inc. and of FPA
New Income, Inc. for more than
the past five years. Director of
TCW Convertible Securities Fund,
Inc., a closed-end investment
company.
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) No pension or retirement benefits are provided to directors by the Fund or
the FPA Fund Complex.
* Director who is an interested person, as defined in the Investment Company
Act, by virtue of his affiliation with legal counsel to the Fund.
14
<PAGE>
<TABLE>
<CAPTION>
OFFICERS
---------------------------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert L. Rodriguez, 51 President & Chief Director (since March 1996), Principal (since March
Investment Officer 1996), Chief Executive Officer (since May 2000) and
Chief Investment Officer (since March 1996) of First
Pacific Advisors, Inc.; President and Chief Investment
Officer of FPA New Income, Inc. for more than the past
five years; and Director of Source Capital, Inc. since
March 1996. Director of FPA Fund Distributors, Inc.
since March 1996. Executive Vice President from January
1996 to March 1996 and Senior Vice President from
February 1993 to January 1996, of First Pacific
Advisors, Inc.; and Senior Vice President of Source
Capital, Inc. from March 1996 to November 1999.
---------------------------------------------------------------------------------------------------------------------------------
Dennis M. Bryan, 38 Vice President Vice President of First Pacific Advisors, Inc. since
January 1996. Investment Analyst of First Pacific
Advisors, Inc. from July 1993 to January 1996.
---------------------------------------------------------------------------------------------------------------------------------
Eric S. Ende, 55 Vice President Senior Vice President of First Pacific Advisors, Inc.
for more than the past five years; President (since
September 1995) and Portfolio Manager (since August
1999) of FPA Perennial Fund, Inc.; Director (since March
2000), President (since March 2000) and Chief Investment
Officer (since May 1997) of Source Capital, Inc.;
Director, President and Portfolio Manager of FPA
Paramount Fund, Inc. since March 2000; and Vice
President of FPA New Income, Inc. for more than the past
five years. Chief Investment Officer from September 1995
to August 1999, Executive Vice President (or Vice
President) from May 1985 to September 1995 of FPA
Perennial Fund, Inc.; Senior Vice President (or Vice
President) from May 1985 to March 2000 of Source
Capital, Inc.; and Vice President from June 1985 to
March 2000 of FPA Paramount Fund, Inc.
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
15
<PAGE>
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------------------
NAME/AGE POSITION HELD WITH FUND PRINCIPAL OCCUPATION(S) DURING PAST 5 YEARS
---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
J. Richard Atwood, 40 Treasurer Director (since May 2000), Principal (since May 2000),
Chief Operating Officer (since May 2000), Chief
Financial Officer (since January 1997) and Treasurer
(since January 1997) of First Pacific Advisors, Inc.;
and Director (since May 2000), President (since May
2000), Chief Executive Officer (since May 2000). Chief
Financial Officer (since March 1998), and Treasurer
(since January 1997) of FPA Fund Distributors, Inc.
Treasurer of Source Capital, Inc., of FPA Paramount
Fund, Inc., of FPA Perennial Fund, Inc., and of FPA New
Income, Inc. since January 1997. Vice President and
Chief Financial Officer of Transamerica Investment
Services, Inc. from January 1995 to January 1997. Senior
Vice President from January 1997 to May 2000 of First
Pacific Advisors, Inc. and of FPA Fund Distributors,
Inc.
---------------------------------------------------------------------------------------------------------------------------------
Sherry Sasaki, 45 Secretary Assistant Vice President and Secretary for more than the
past five years of First Pacific Advisors, Inc.; and
Secretary of Source Capital, Inc., of FPA New Income,
Inc., of FPA Paramount Fund, Inc., of FPA Perennial Fund,
Inc., and of FPA Fund Distributors, Inc. for more than
the past five years.
---------------------------------------------------------------------------------------------------------------------------------
Christopher H. Thomas, 43 Assistant Treasurer Vice President and Controller of First Pacific Advisors,
Inc. from more than the past five years; Director (since
May 2000), Vice President and Controller for more than
the past five years of FPA Fund Distributors, Inc.; and
Assistant Treasurer of FPA Perennial Fund, Inc., of FPA
New Income, Inc., of Source Capital, Inc., and of FPA
Paramount Fund, Inc. for more than the past five years.
---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
All officers of the Fund are also officers of the Adviser. The Directors and
officers of the Fund as a group own less than 1% of the outstanding Fund shares.
During the last fiscal year, the Directors then in office received as a group
$33,280 in Directors' fees. Such Directors were also reimbursed for certain
travel expenses by the Fund.
FIVE PERCENT SHAREHOLDERS
As of June 30, 2000, no person was known by the Fund to own of record or
beneficially 5% or more of the outstanding Fund shares, except Merrill Lynch,
Pierce, Fenner & Smith, Inc., for the sole benefit of its customers, Attention:
Fund Administration 97224, 4800 Deer Lake Drive, East Floor 2, Jacksonville,
Florida 32246-6484, which held 861,834 shares (5.9%). Such broker-dealer advises
that the shares are held for the benefit of its customers.
16
<PAGE>
MANAGEMENT
INVESTMENT ADVISER. First Pacific Advisors, Inc., together with its
predecessors, has been in the investment advisory business since 1954, serving
as investment adviser to the Fund since July 11, 1984. Presently, the investment
adviser manages assets of approximately $3.1 billion for seven investment
companies, including one closed-end investment company, and 19 institutional
accounts. Currently, the personnel of First Pacific Advisors, Inc. consists of
seven persons engaged full time in portfolio management or investment research
in addition to 23 persons engaged full time in trading, administrative,
financial or clerical activities. The Fund, the Adviser and the Distributor have
adopted Codes of Ethics designed to prevent officers and employees who may have
access to nonpublic information about the trading activities of the Fund (access
persons) from profiting from that information. The Codes permit access persons
to invest in securities for their own accounts, including securities that may be
held by the Fund, but place substantive and procedural restrictions on their
trading activities. For example, the Codes require that access persons receive
advance approval for every securities trade to ensure that there is no conflict
with the trading activities of the Fund.
First Pacific Advisors, Inc., is a wholly owned subsidiary of United Asset
Management Holdings, Inc. United Asset Management Holdings, Inc. is a wholly
owned subsidiary of UAM, a New York Stock Exchange listed holding company
principally engaged, through affiliated firms, in providing institutional
investment management and acquiring institutional investment management firms.
No person is known by UAM to own or hold with power to vote 25% or more of its
outstanding shares of common stock.
INVESTMENT ADVISORY AND SERVICE AGREEMENT. The Fund has entered into an
Investment Advisory Agreement dated August 1, 1994 ("Advisory Agreement"), with
the Adviser pursuant to which the Adviser provides continuing supervision of the
Fund's investment portfolio. The Adviser is authorized, subject to the control
of the Fund's Board of Directors, to determine which securities are to be bought
or sold and in what amounts. In addition to providing investment advisory and
management services, the Adviser furnishes office space, facilities and
equipment, and maintains the Fund's books and records. It also compensates all
officers and other personnel of the Fund, all of whom are employed by the
Adviser, subject to reimbursement from the Fund for personnel involved in
providing financial services as indicated below.
Other than the expenses the Adviser specifically assumes under the Advisory
Agreement, the Fund bears all costs of its operation. These costs include the
charges and expenses of any custodian or depository appointed by the Fund for
the safekeeping of its cash, portfolio securities and other property; the
charges and expenses of auditors; the charges and expenses of any stock transfer
or dividend agent or agents appointed by the Fund; brokers' commissions
chargeable to the Fund in connection with portfolio securities transactions to
which the Fund is a party; all taxes, including issuance and transfer taxes, and
corporate fees payable by the Fund to federal, state or other governmental
agencies; the cost of stock certificates representing Fund shares; fees involved
in registering and maintaining registrations of the Fund and of Fund shares with
the Securities and Exchange Commission ("SEC") and various states and other
jurisdictions; all expenses of shareholders' and Directors' meetings and of
preparing, printing and mailing proxy statements and semi-annual and annual
reports to shareholders except as set forth in the Distribution Agreement
between the Fund and the Distributor; fees and travel expenses of independent
and unaffiliated Directors; the expense of furnishing, or causing to be
furnished, to all shareholders a statement of account after every transaction
affecting their account, including the expense of mailing; charges and expenses
of legal counsel in connection with matters relating to the Fund, including,
without limitation, legal services rendered in connection with the Fund's
corporate and financial structure and relations with its shareholders,
17
<PAGE>
issuance of Fund shares, and registrations and qualifications of securities
under federal, state and other laws; association dues; interest payable on Fund
borrowings; postage; and reimbursement of the Adviser's expenses in providing
financial services to the Fund as described below.
For services rendered, the Adviser is paid a monthly fee computed at the annual
rate of 0.75% of the first $50 million, and 0.65% of the excess over $50
million, of the Fund's average net assets. The average net assets are determined
by taking the average of all the daily determinations of net assets made, in the
manner provided in the Fund's Articles of Incorporation, during a calendar
month.
In addition to the advisory fee, the Fund reimburses the Adviser monthly for
costs incurred in providing financial services to the Fund. Such financial
services include (a) maintaining the accounts, books and other documents forming
the basis for the Fund's financial statements, (b) preparing such financial
statements and other Fund documents and reports of a financial nature required
by federal and state laws, (c) calculating daily net assets and (d)
participating in the production of the Fund's registration statements,
prospectuses, proxy materials and reports to shareholders (including
compensation of the Treasurer or other principal financial officer of the Fund,
compensation of personnel working under such person's direction and expenses of
office space, facilities and equipment such persons use to perform their
financial services duties). However, for any fiscal year, the cost of such
financial services paid by the Fund cannot exceed 0.10% of the average daily net
assets of the Fund.
The advisory fee and cost of financial services is reduced in the amount by
which certain defined operating expenses of the Fund (including the advisory fee
and cost of financial services) for any fiscal year exceed 1.50% of the first
$30 million of average net assets, plus 1% of the remaining average net assets.
Such values are calculated at the close of business on the last business day of
each calendar month. Any required reduction or refund is computed and paid
monthly. Operating expenses (as defined in the Advisory Agreement) exclude (a)
interest, (b) taxes, (c) brokerage commissions and (d) any extraordinary
expenses, such as litigation, merger, reorganization or recapitalization, to the
extent such extraordinary expenses can be excluded under the rules or policies
of the states in which Fund shares are registered for sale. All expenditures,
including costs connected with the purchase, retention or sale of portfolio
securities, which are capitalized in accordance with generally accepted
accounting principles applicable to investment companies, are accounted for as
capital items and not as expenses. This expense limitation provision does not
require any payment by the Adviser beyond the return of the advisory fee and
cost of financial services paid to it by the Fund for a fiscal year.
The Advisory Agreement provides that the Adviser does not have any liability to
the Fund or any of its shareholders for any error of judgment, any mistake of
law or any loss the Fund suffers in connection with matters related to the
Advisory Agreement, except for liability resulting from willful misfeasance, bad
faith or negligence on the part of the Adviser or the reckless disregard of its
duties under the Advisory Agreement.
The Advisory Agreement is renewable annually if specifically approved each year
(a) by the Fund's Board of Directors or by the vote of a majority (as defined in
the Investment Company Act) of the Fund's outstanding voting securities and (b)
by the vote of a majority of the Fund's directors who are not parties to the
Advisory Agreement or interested persons (as defined in the Investment Company
Act) of any such party, by votes cast in person at a meeting called for the
purpose of voting on such approval. The continuation of the Advisory Agreement
to September 30, 2001, has been approved by the Board of Directors and a
majority of the Fund's directors who are not parties to the Advisory Agreement
or interested persons of any such party (as defined in the Investment Company
Act). The Advisory
18
<PAGE>
Agreement may be terminated without penalty upon 60 days' written notice at the
option of either party or by the vote of the Fund's shareholders. The Advisory
Agreement automatically terminates in the event of its assignment.
For the fiscal years ended March 31, 1998, 1999 and 2000, the Adviser received
gross advisory fees of $4,622,631, $4,508,974 and $3,538,917, respectively, plus
$703,482, $685,996 and $536,756, respectively, for costs incurred in providing
financial services to the Fund.
PRINCIPAL UNDERWRITER. FPA Fund Distributors, Inc. (the "Distributor"), located
at 11400 West Olympic Boulevard, Suite 1200, Los Angeles, California 90064, acts
as principal underwriter of Fund shares pursuant to a Distribution Agreement
dated August 1, 1994 (the "Distribution Agreement"). The Distributor is a wholly
owned subsidiary of the Adviser. Please see "Distributor" for more information.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Adviser makes decisions to buy and sell securities for the Fund, selects
broker-dealers and negotiates commission rates or net prices. In
over-the-counter transactions, orders are placed directly with a principal
market maker unless the Adviser believes better prices and executions are
available elsewhere. Portfolio transactions are effected with broker-dealers
selected for their abilities to give prompt execution at prices favorable to the
Fund. In selecting broker-dealers and in negotiating commissions, the Adviser
considers: the best net price available; each firm's reliability, integrity and
financial condition; the size of and difficulty in executing the order; and the
value of the firm's expected contribution to the Fund's investment performance
on a continuing basis. Accordingly, the net price to the 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 its services. Subject to
policies determined by the Fund's Board of Directors, the Adviser shall not be
deemed to have acted unlawfully or to have breached any duty created by the
Advisory Agreement or otherwise solely because the Fund paid a broker-dealer
providing brokerage and research services commissions for effecting a
transaction in excess of the commission another broker-dealer would have charged
for the same transaction. The Adviser must determine in good faith that such
commission was reasonable relative to the value of the brokerage and research
services provided, considering either that particular transaction or the
Adviser's overall responsibilities to the Fund. The Adviser is further
authorized to allocate orders it places for the Fund to broker-dealers providing
products or services which assist in making investment decisions. The Adviser
allocates the amounts and proportions of such costs and regularly reports on
such allocations to the Fund's Board of Directors.
Brokerage and research services are defined by Section 28(e) of the Securities
Exchange Act of 1934 to include (a) providing advice as to the value of
securities, the advisability of investing in, purchasing or selling securities,
and the availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy and performance of accounts; and
(c) effecting securities transactions and performing functions incidental
thereto, such as clearance, settlement and custody.
Research services furnished by broker-dealers effecting securities transactions
for the Fund can be used by the Adviser for all advisory accounts. However, the
Adviser might not use all such research services in managing the Fund's
portfolio. In the Adviser's opinion, it is not possible to measure separately
the benefits from research services to each advisory account. Because the volume
and nature of the trading activities of advisory accounts are not uniform, the
amount of commissions in excess of the lowest available rate paid by each
advisory account for brokerage and research services will vary. However, the
Adviser
19
<PAGE>
believes the total commissions the Fund pays are not disproportionate to the
benefits it receives on a continuing basis.
The Adviser attempts to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell securities for the Fund and
another advisory account. In some cases, this procedure could have an adverse
effect on the price or amount of securities available to the Fund. The main
factors considered in such allocations are the respective investment objectives,
the relative amount of portfolio holdings of the same or comparable securities,
the availability of cash for investment, the size of investment commitments
generally held, and the opinion of the persons responsible for recommending the
investments.
Brokerage commissions paid by the Fund on portfolio transactions for the fiscal
years ended March 31, 1998, 1999 and 2000, totaled $370,377, $376,934 and
$585,690, respectively. During the last fiscal year, $534,521 of commissions
were paid on transactions having a total value of $243,461,956 to brokers
selected because of research services provided to the Adviser.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of purchases or
sales of portfolio securities for a fiscal year by the average monthly value of
the portfolio securities during such fiscal year. Securities maturing in one
year or less at the time of acquisition are not included in this computation.
The turnover rate for prior periods is shown in the Prospectus under the caption
"Financial Highlights." This rate may vary greatly from year to year as well as
within a year.
CAPITAL STOCK
COMMON STOCK. Each Fund share outstanding participates equally in dividends,
distributions and liquidation of the Fund's net assets. Fund shares are
transferable, fully paid and non-assessable, and do not have any preemptive,
preferential, subscription or conversion rights. The Fund has authorized 100
million shares of $0.01 par value Common Stock.
VOTING RIGHTS. The By-Laws of the Fund require shareholder meetings to elect
directors only when required by the Investment Company Act, which is likely to
occur infrequently. In addition, a special meeting of the shareholders will be
called, if requested by the holders of 10% of the Fund's outstanding shares, for
the purposes, and to act upon the matters, specified in the request (which may
include election or removal of directors). When matters are submitted for a
shareholder vote, each shareholder is entitled to one vote for each share owned.
Shares of the Fund do not have cumulative voting rights, which means holders of
more than 50% of Fund shares voting for the election of directors can elect 100%
of the directors if they so choose. In such event, holders of the remaining Fund
shares are not able to elect any person or persons to the Fund's Board of
Directors.
PURCHASE AND REDEMPTION OF SHARES
NET ASSET VALUE. The net asset value is computed as of the close of the New York
Stock Exchange ("NYSE") on each business day during which the NYSE is open. Net
asset value, rounded to the nearest cent per share, is the total market value of
all the Fund's portfolio securities plus other assets (including any accrued
reimbursement of expenses), less all liabilities, divided by the total number of
Fund shares outstanding. The NYSE is closed not only on weekends but also on
customary holidays, which currently are New Year's Day, Martin Luther King, Jr.
Day, President's Day, Good Friday, Memorial Day,
20
<PAGE>
Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Computation is
made by valuing (a) securities listed or traded on a national securities
exchange or on the National Association of Securities Dealers Automated
Quotations NASDAQ National Market System ("NASDAQ") at the last sale price or,
if there has been no sale that day, at the last bid price, (b) unlisted
securities for which quotations are readily available at the last representative
bid price as supplied by the NASDAQ or by dealers, and (c) securities for which
there are no readily available market quotations and all other assets at fair
value in such manner as determined in good faith by the Fund's Board of
Directors.
SALES CHARGES. The maximum sales charge is 6.5%, as a percentage of the offering
price, but lower sales charges apply to larger purchases. A portion of the sales
charge is allocated to dealers selling Fund shares in amounts ranging from 80%
to 94%, depending on the size of the investment. During special promotions, the
Distributor may reallow up to 100% of the sales charge to dealers. At such
times, dealers may be deemed to be underwriters for purposes of the Securities
Act of 1933. Discounts are alike to all dealers.
AUTHORIZED FINANCIAL INTERMEDIARIES. The Fund has authorized certain financial
intermediaries including one or more brokers to accept on its behalf purchase
and redemption orders. These brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
The Fund is deemed to have received a purchase or redemption order when an
authorized financial intermediary including an authorized broker or if
applicable a broker's authorized designee accepts the order. Customer orders are
priced at the Fund's net asset value next computed after they are accepted by an
authorized financial intermediary, including an authorized broker or the
broker's authorized designee.
SALES AT NET ASSET VALUE. Full-time employees of the Adviser can purchase Fund
shares at net asset value via payroll deduction, provided the minimum initial
investment is $250. Each subsequent investment must be at least $50.
LETTER OF INTENT. To be eligible for reduced sales charges, the investor must
sign at the time of initial purchase, or within 30 days, a Letter of Intent
("LOI") covering investments to be made within a period of 13 months ("Period")
from the initial purchase. The investor then becomes eligible for a reduced
sales charge based on the total amount of the specified intended investment
("LOI Goal"), provided the amount is not less than $10,000. A minimum initial
purchase of $1,500 and minimum subsequent purchases of $100 each are required.
Fund shares can also be purchased to fulfill a letter of intent entered into
with respect to shares of the other FPA Funds. The account information form,
which should be used to establish an LOI, is available from dealers or the
Distributor.
All transactions under an LOI must be indicated as such and must be placed by
the dealer (in the case of an initial purchase) or the shareholder (in the case
of any subsequent purchase) directly through Boston Financial Data Services,
Inc. ("Shareholder Service Agent"). Shareholders should review for accuracy all
confirmations of transactions, especially purchases made pursuant to an LOI.
If the LOI Goal is completed before the end of the Period, any subsequent
purchases within the Period receive the applicable reduced sales charge. In
addition, during the Period, the shareholder can increase his or her LOI Goal,
and all subsequent purchases are treated as a new LOI (including escrow of
additional Fund shares) except as to the Period, which does not change.
Signing an LOI does not bind the shareholder to complete his or her LOI Goal,
but the LOI Goal must be completed to obtain the reduced sales charge. The LOI
is binding on the Fund and the Distributor.
21
<PAGE>
However, the Distributor may withdraw a shareholder's LOI privileges for future
purchases upon receiving information that the shareholder has resold or
transferred his or her Fund shares within the Period.
The LOI requires the Shareholder Service Agent, as escrow agent, to hold 5% of
the LOI Goal in escrow until completion of the LOI Goal within the Period. The
escrowed Fund shares are taken from the first purchase and, if necessary, from
each successive purchase. If the LOI Goal is completed within the Period, the
escrowed Fund shares are promptly delivered to, or as directed by, the
shareholder.
If the LOI Goal is not completed within the Period, the shareholder must pay the
Distributor an amount equal to the sales charge applicable to a single purchase
in the total amount of the purchases made under the LOI minus the sales charges
actually paid. If the Distributor does not receive such unpaid sales charge
within 20 days after requesting payment in writing, the Distributor instructs
the Shareholder Service Agent to redeem escrowed Fund shares sufficient to cover
the unpaid sales charge. Under the LOI, the shareholder irrevocably appoints the
Shareholder Service Agent as his or her attorney with full power of substitution
to surrender for redemption any or all escrowed Fund shares. If the redemption
proceeds are inadequate, the shareholder is liable to the Distributor for the
difference. The Shareholder Service Agent delivers to, or as directed by, the
shareholder all Fund shares remaining after such redemption, together with any
excess cash proceeds.
Any income dividends and capital gains distributions on the escrowed Fund shares
are paid or reinvested as directed by, the shareholder.
FPA EXCHANGE PRIVILEGE. The procedures for exchanging shares between FPA Funds
are described under "Exchanging Your Fund Shares" in the Fund's Prospectus. If
the account registration information for the two FPA Fund accounts involved in
the exchange are different in any respect, the exchange instructions must be in
writing and must contain a signature guarantee as described under "Selling
(Redeeming) Your Shares" in the Fund's Prospectus.
By use of the exchange privilege, the investor authorizes the Shareholder
Service Agent to act on telephonic, telegraphic or written exchange instructions
from any person representing himself to be the investor or the agent of the
investor and believed by the Agent to be genuine. The Shareholder Service Agent
uses procedures it considers reasonable to confirm exchange instructions via
telephone, including requiring account registration verification from the caller
and recording telephone instructions. Neither the Shareholder Service Agent nor
the Fund is liable for losses due to unauthorized or fraudulent instructions if
there is a reasonable belief in the authenticity of received instructions and
reasonable procedures are employed; otherwise, they may be liable. The
Shareholder Service Agent's records of such instructions are binding.
For purposes of determining the sales charge rate previously paid, all sales
charges paid on the exchanged security and on any security previously exchanged
for such security or for any of its predecessors will be included. If the
exchanged security was acquired through reinvestment, that security may be
exchanged without a sales charge. If a shareholder exchanges less than all of
his securities, the security requiring no or the lowest incremental sales charge
is deemed exchanged first.
Exchange requests received on a business day before shares of the Funds involved
in the request are priced, are processed on the date of receipt by the
Shareholder Service Agent. "Processing" a request means that shares in the Fund
from which the shareholder is withdrawing an investment will be redeemed at the
net asset value per share next determined after receipt. Shares of the new Fund
into which the shareholder is investing will also normally be purchased at the
net asset value per share, plus any applicable sales charge, next determined
after receipt by the Shareholder Service Agent. Exchange requests received on a
business
22
<PAGE>
day after the time shares of the Funds involved in the request are priced, are
processed on the next business day as described above.
REDEMPTION OF SHARES. Redemptions are not made on days when the NYSE is closed,
including those holidays listed under "Purchase and Redemption of Shares - Net
Asset Value." The right of redemption can be suspended and the payment therefore
may be postponed for more than seven days during any period when (a) the NYSE is
closed for other than customary weekends or holidays; (b) trading on the NYSE is
restricted; (c) an emergency exists as a result of which disposal by the Fund of
securities it owns is not reasonably practicable or it is not reasonably
practicable for the Fund to fairly determine the value of its net assets; or (d)
the Securities and Exchange Commission, by order, so permits. The Articles of
Incorporation of the Fund provide that if the Board of Directors determines that
conditions exist which make payment of the redemption price wholly in cash
unwise or undesirable, the Fund may make payment wholly or partly in securities
or other assets. While the Fund generally does not reserve the right to pay
redemption proceeds "in-kind," it may do so if requested by a large shareholder
and approved by the Board.
TELEPHONE REDEMPTION. Redemptions can be made by telephone once the shareholder
has properly completed and returned to the Shareholder Service Agent the account
information form. The shareholder may direct that a check for the proceeds
payable to the shareholder of record be mailed to the address of record or they
may designate a bank account ("Designated Bank") to which the proceeds of such
redemptions are sent. New investors who wish to establish the telephone
redemption privilege must complete the appropriate section on the account
information form. Existing shareholders who wish to establish the telephone
redemption privilege or change the Designated Bank should either enter the new
information on an account information form, marking it for "change of
information" purposes, or send a letter identifying the Fund account and
specifying the exact information to be changed. The letter must be signed
exactly as the shareholder's name(s) appear on the account. All signatures
require a guarantee as described under "Selling (Redeeming) Your Shares" in the
Fund's Prospectus. The account information form is available from authorized
security dealers or the Distributor.
Shareholders who want to use a savings and loan ("S&L") as their Designated Bank
are advised that if the S&L is not a participant in the Federal Reserve System,
redemption proceeds must be wired through a commercial bank which is a
correspondent of the S&L. As this may delay receipt by the shareholder's
account, it is suggested that shareholders who wish to use an S&L discuss wire
procedures with their S&L and submit any special wire transfer information with
the telephone redemption authorization. If appropriate wire information is not
supplied, redemption proceeds will be mailed to such Designated Bank.
A shareholder can cancel the telephone redemption authorization upon written
notice. If the shareholder has authorized telephone redemptions, neither the
Fund nor the Shareholder Service Agent is responsible for any unauthorized
telephone redemptions. If the Fund shares to be redeemed by telephone
(technically a repurchase by agreement between the Fund and the shareholder)
were recently purchased by check, the Shareholder Service Agent can delay
transmitting the proceeds until the purchasing check has cleared but no more
than 15 days from purchase.
The Shareholder Service Agent uses procedures it considers reasonable to confirm
redemption instructions via telephone, including requiring account registration
verification from the caller and recording telephone instructions. Neither the
Shareholder Service Agent nor the Fund is liable for losses due to unauthorized
or fraudulent instructions if there is a reasonable belief in the authenticity
of received instructions and reasonable procedures are employed; otherwise, they
may be liable.
23
<PAGE>
TAX SHELTERED RETIREMENT PLANS
Through the Distributor, prototype retirement plans are available for purchase
of Fund shares. These include plans for self-employed individuals and plans for
individuals buying shares under an Individual Retirement Account. A penalty tax
applies, in general, to distributions made before age 59-1/2, excess
contributions and failure to start distribution of the account at age 70-1/2.
Borrowing from or against the account could also result in plan
disqualification. Distributions from these retirement plans generally are
taxable as ordinary income when received.
State Street Bank and Trust Company ("Bank") presently acts as custodian for
these retirement plans and imposes fees for administering them. Purchases of
Fund shares for a retirement plan must be made by direct remittance to the Bank.
When contributions for any tax-qualified plan are invested in Fund shares, all
dividends and capital gains distributions paid on those Fund shares are retained
in the plan and automatically reinvested in additional Fund shares at net asset
value. All earnings accumulate tax-free until distribution.
The investor should consult his or her own tax adviser concerning the tax
ramifications of establishing, and distributions from, a retirement plan.
DIVIDENDS, DISTRIBUTIONS AND TAXES
The Fund qualified during the last fiscal year for the tax treatment applicable
to regulated investment companies under the Internal Revenue Code ("Code") and
intends to so qualify in the future. Such qualification requires distributing at
least 90% of its investment company taxable income to shareholders and meeting
asset diversification and other requirements of the Code. As long as the Fund so
qualifies, it does not pay federal income tax on its net investment income or on
any net realized capital gains provided such income and capital gains are
distributed to shareholders. If for any taxable year the Fund does not so
qualify, all of its taxable income, including any net realized capital gains,
will be taxed at regular corporate rates (without any deduction for
distributions to shareholders).
The Fund is subject to a 4% excise tax to the extent it does not make certain
distributions to its shareholders. Such distributions must total (1) at least
98% of ordinary income (investment company taxable income subject to certain
adjustments) for any calendar year and (2) 98% of capital gains net income for
the 12 months ended October 31 of such year. The Fund intends to distribute
sufficient amounts to avoid liability for this excise tax.
If shares of the Fund are sold or exchanged within 90 days of acquisition, and
shares of the same or a related mutual fund are acquired, to the extent the
sales charge is reduced or waived on the subsequent acquisition, the sales
charge may not be used to determine the basis in the disposed shares for
purposes of determining gain or loss. To the extent the sales charge is not
allowed in determining gain or loss on the initial shares, it is capitalized in
the basis of the subsequent shares.
Under federal tax law, any loss a shareholder realizes on redemption of Fund
shares held for less than six months is treated as a long-term capital loss to
the extent of any long-term capital gain distribution which was paid on such
Fund shares.
Prior to purchasing Fund shares, the impact of dividends or capital gains
distributions should be carefully considered. Any such payments made to a
shareholder shortly after purchasing Fund shares reduce the net asset value of
such Fund shares to that extent and unnecessarily increase sales charges. All or
a portion
24
<PAGE>
of such dividends or distributions, although in effect a return of capital, is
subject to taxes, possibly at ordinary income tax rates.
Dividends and distributions declared payable to shareholders of record after
September 30 of any year and paid before February 1 of the following year are
considered taxable income to shareholders on the record date even though paid in
the next year. To the extent determined each year, a portion of the dividends
paid to shareholders from the Fund's net investment income qualifies for the 70%
dividends received deduction for corporations.
Some shareholders may be subject to 31% withholding on reportable dividends,
capital gains distributions and redemption payments ("backup withholding").
Generally, shareholders subject to backup withholding are those for whom a
taxpayer identification number is not on file with the Fund or who, to the
Fund's knowledge, furnished an incorrect number. When establishing an account,
an investor must certify under penalty of perjury that such number is correct
and that he or she is not subject to backup withholding.
Under existing provisions of the Code, dividends paid to shareholders who are
nonresident aliens may be subject to a 30% federal withholding tax applicable to
foreign individuals and entities unless a reduced rate of withholding or a
withholding exemption is provided under applicable treaty law. Nonresident
shareholders are urged to consult their own tax advisers concerning the
applicability of the federal withholding tax.
The foregoing is a general and abbreviated summary of the applicable provisions
of the Code and Treasury Regulations presently in effect. For the complete
provisions, reference should be made to the pertinent Code sections and Treasury
Regulations. The Code and Treasury Regulations are subject to change by
legislative or administrative action either prospectively or retroactively.
Each investor should consult his or her own tax adviser as to federal tax laws
and the effect of state and local tax laws which may differ from federal tax
laws.
DISTRIBUTOR
The Distributor acts as principal underwriter of Fund shares pursuant to the
Distribution Agreement. The offering of Fund shares is a continuous offering.
The Distributor receives commissions from the sale of Fund shares and has the
exclusive right to distribute Fund shares through dealers. From commissions
received, the Distributor pays sales commissions to dealers; its own overhead
and general administrative expenses; the cost of printing and distributing Fund
prospectuses; and the cost of printing and distributing sales literature and
advertising relating to the Fund. The Fund pays expenses attributable to
registering Fund shares under federal and state laws (including registration and
filing fees) and related legal and audit expenses.
The Distribution Agreement is renewable annually if specifically approved each
year (a) by the Fund's Board of Directors or by a vote of a majority (as defined
in the Investment Company Act) of the Fund's outstanding voting securities and
(b) by a majority of the Fund's directors who are not parties to the
Distribution Agreement or interested persons (as defined in the Investment
Company Act) of any such party, by votes cast in person at a meeting called for
such purpose. The continuation of the Distribution Agreement to September 3,
2001 has been approved by the Board of Directors and a majority of the Fund's
directors who are not parties to the Distribution Agreement or interested
persons of any such party (as defined in the Investment Company Act). The
Distribution Agreement terminates if assigned (as defined in the Investment
Company Act) and may be terminated at any time on 60 days' written notice,
without penalty, by the Fund's Board of Directors, the vote of a majority of the
Fund's outstanding voting
25
<PAGE>
securities or the Distributor.
The Distributor's obligation under the Distribution Agreement is an agency or
best efforts arrangement pursuant to which the Distributor is required to take
and pay for only those Fund shares sold to the public. The Distributor is not
obligated to sell any stated number of Fund shares. The Distributor is a
subsidiary of the Adviser.
For the fiscal years ended March 31, 1998, 1999 and 2000, underwriting
commissions on the sale of Fund shares were $518,766, $269,968 and $124,942,
respectively. Of such totals, the amount retained each year by the Distributor,
after reallowance to other dealers, was $40,556, $21,376 and 9,764,
respectively.
PRIOR PERFORMANCE INFORMATION
For the purposes of quoting and comparing the performance of the Fund to that of
other mutual funds and to other relevant market indices in advertisements,
performance may be stated in terms of total return. Under regulations adopted by
the Securities and Exchange Commission ("SEC"), funds that intend to advertise
performance must include total return quotations calculated according to the
following formula:
n
P(1 + T) = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)
ERV = ending redeemable value of a hypothetical
$1,000 payment, made at the beginning of the 1, 5 or
10 year period, at the end of such period (or
fractional portion thereof).
Under the foregoing formula, the time periods used in advertising will be based
on rolling calendar quarters, updated to the last day of the most recent quarter
prior to submission of the advertising for publication, and cover 1, 5 and
10-year periods of a fund's existence or such shorter period dating from the
effectiveness of a fund's registration statement. In calculating the ending
redeemable value, the maximum sales load is deducted from the initial $1,000
payment and all dividends and distributions by a fund are assumed to have been
reinvested at net asset value as described in the Prospectus on the reinvestment
dates during the period. Total return, or "T" in the formula above, is computed
by finding the average annual compounded rates of return over the 1, 5 and
10-year periods (or fractional portion thereof) that would equate the initial
amount invested to the ending redeemable value.
The Fund may also from time to time include in such advertising a total return
figure that is not calculated according to the formula set forth above in order
to compare the performance of the Fund with other measures of investment return.
For example, in comparing the Fund's total return with a stock index such as the
Russell 2000 Index, the Fund calculates its aggregate total return for the
specified periods of time by assuming the investment of $10,000 in Fund shares
and assuming the reinvestment of each dividend or other distribution at net
asset value on the reinvestment date. Percentage increases are determined by
subtracting the initial value of the investment from the ending value and by
dividing the remainder by the beginning value. The Fund does not, for these
purposes, deduct from the initial value invested any amount representing sales
charges. The Fund, however, discloses the maximum sales charge and also
discloses that inclusion of sales charges would reduce the performance quoted.
Such alternative total return information will be given no greater prominence in
such advertising than the information prescribed under
26
<PAGE>
SEC regulations.
The Fund's average annual total return (calculated in accordance with the SEC
regulations described above) for the 1, 5 and 10-year periods ended March 31,
2000 was 17.24%, 18.39% and 18.61%, respectively. The Fund's average annual
total return (determined pursuant to the alternative computation which does not
include the maximum initial sales charge of 6.5% of the offering price) for the
same periods was 25.39%, 19.99% and 19.41%, respectively. These results are
based on historical earnings and asset value fluctuations and are not intended
to indicate future performance.
The foregoing information should be considered in light of the Fund's investment
objectives and policies, as well as the risks incurred in the Fund's investment
practices. Future results will be affected by the future composition of the
Fund's portfolio, as well as by changes in the general price level of equity
securities, and general economic and other market conditions. The past 1, 5 and
10-year periods have been ones of generally rising common stock prices subject
to short-term fluctuations.
27
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 2000
<TABLE>
<CAPTION>
COMMON STOCKS Shares Value
------------- ------------- ----------------
<S> <C> <C>
TECHNOLOGY -- 27.3%
Arrow Electronics, Inc.*..................................................... 1,319,500 $ 46,512,375
Avnet, Inc................................................................... 766,935 48,316,905
Exabyte Corporation*+........................................................ 1,176,600 8,750,963
Hutchinson Technology Incorporated*.......................................... 624,300 11,003,287
KEMET Corporation*........................................................... 60,000 3,795,000
Storage Technology Corporation*.............................................. 1,445,600 23,039,250
---------------
$ 141,417,780
---------------
RETAILING -- 23.9%
Consolidated Stores Corporation*............................................. 1,609,100 $ 18,303,513
Craig Corporation (Class "A")*............................................... 269,000 1,193,688
Good Guys, Inc., The*........................................................ 441,300 1,820,362
Gymboree Corporation, The*+.................................................. 1,078,800 4,450,050
HomeBase, Inc.*+............................................................. 2,049,400 4,098,800
Michaels Stores, Inc.*....................................................... 1,260,700 51,373,525
Ross Stores, Inc............................................................. 1,760,500 42,362,031
---------------
$ 123,601,969
---------------
CONSUMER DURABLES -- 13.8%
Centex Corporation........................................................... 537,100 $ 12,789,694
Champion Enterprises, Inc.*.................................................. 1,903,600 10,945,700
Coachmen Industries, Inc.+................................................... 840,500 11,609,406
Fleetwood Enterprises, Inc................................................... 904,900 13,347,275
Flexsteel Industries, Inc.................................................... 134,500 1,647,625
Recoton Corporation*+........................................................ 630,400 7,446,600
Thor Industries, Inc......................................................... 555,000 13,493,438
---------------
$ 71,279,738
---------------
FINANCIAL -- 10.0%
Conseco, Inc................................................................. 1,534,900 $ 17,555,419
Countrywide Credit Industries, Inc........................................... 644,300 17,557,175
Horace Mann Educators Corporation............................................ 729,100 13,442,781
Westcorp..................................................................... 247,100 3,459,400
---------------
$ 52,014,775
---------------
</TABLE>
28
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 2000
<TABLE>
<CAPTION>
Shares or
Principal
COMMON STOCKS--CONTINUED Amount Value
------------------------ ------------- ----------------
<S> <C> <C>
ENERGY -- 7.0%
ENSCO International Incorporated............................................. 1,000,000 $ 36,125,000
---------------
INDUSTRIAL PRODUCTS -- 2.7%
Belden Inc................................................................... 504,300 $ 13,868,250
---------------
CONSUMER NON-DURABLES -- 2.5%
CPI Corp..................................................................... 330,000 $ 7,693,125
Rawlings Sporting Goods Company, Inc.*....................................... 189,100 850,950
Reebok International Ltd.*................................................... 508,400 4,702,700
---------------
$ 13,246,775
---------------
BASIC MATERIALS -- 2.2%
International Aluminum Corporation........................................... 168,100 $ 2,626,562
Oregon Steel Mills, Inc...................................................... 990,100 3,836,638
Rouge Industries, Inc. (Class "A")........................................... 752,300 4,748,894
---------------
$ 11,212,094
---------------
BUSINESS SERVICES & SUPPLIES -- 2.0%
Angelica Corporation+........................................................ 504,300 $ 5,011,481
Manpower Inc................................................................. 150,000 5,325,000
---------------
$ 10,336,481
---------------
DEFENSE -- 0.8%
DRS Technologies, Inc.*...................................................... 428,700 $ 4,260,206
---------------
TOTAL COMMON STOCKS -- 92.2% (Cost $390,392,380)............................. $ 477,363,068
---------------
NON-CONVERTIBLE BONDS & DEBENTURES -- 5.5%
Federal Home Loan Mortgage Corporation (IO) -- 7% 2020....................... $ 3,156,714 $ 276,212
Trump Atlantic City Associates -- 11 1/4% 2006............................... 4,000,000 2,620,000
U.S. Treasury Inflation-Indexed Notes -- 3 4/8% 2007......................... 26,561,320 25,548,670
---------------
TOTAL NON-CONVERTIBLE BONDS & DEBENTURES
(Cost $29,882,705)........................................................ $ 28,444,882
---------------
TOTAL INVESTMENT SECURITIES -- 97.7%
(Cost $420,275,085)....................................................... $ 505,807,950
---------------
</TABLE>
29
<PAGE>
PORTFOLIO OF INVESTMENTS
March 31, 2000
<TABLE>
<CAPTION>
Principal
Amount Value
------------- ----------------
<S> <C> <C>
SHORT-TERM CORPORATE NOTES -- 2.3%
American Express Credit Corporation -- 6.2% 4/3/00........................... $ 3,949,000 $ 3,947,640
Ford Motor Credit Corporation
--6.05% 4/4/00.............................................................. 3,956,000 3,954,006
--6.06% 4/5/00.............................................................. 2,371,000 2,369,403
--6.04% 4/6/00.............................................................. 1,878,000 1,876,424
---------------
TOTAL SHORT-TERM INVESTMENTS (Cost $12,147,473).............................. $ 12,147,473
---------------
TOTAL INVESTMENTS -- 100.0%
(Cost $432,422,558)....................................................... $ 517,955,423
Other assets and liabilities, net ........................................... (55,296)
---------------
TOTAL NET ASSETS -- 100.0%................................................... $ 517,900,127
---------------
---------------
</TABLE>
* Non-income producing securities
+ Affiliate as defined in the Investment Company Act of 1940 by reason of
ownership of 5% or more of its outstanding voting securities during the year
ended March 31, 2000. Following is a summary of transactions in securities of
these affiliates during the year ended March 31, 2000.
<TABLE>
<CAPTION>
Purchases Sales Realized Dividend
at Cost at Cost Gain (Loss) Income
------------------------------------------------------
<S> <C> <C> <C> <C>
Angelica Corporation -- -- -- $484,128
Coachmen Industries, Inc. -- -- -- 168,100
Exabyte Corporation -- -- -- --
Gymboree Corporation -- $5,005,090 $(3,692,634) --
HomeBase, Inc. -- -- -- --
Marshall Industries $580,515 See Below -- --
Recoton Corporation -- -- -- --
</TABLE>
All of the common stock of Marshall Industries was converted into Avnet, Inc.
in a non-taxable acquisition during the year ended March 31, 2000.
See notes to financial statements.
30
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES
March 31, 2000
<TABLE>
<S> <C> <C>
ASSETS
Investments at value:
Investment securities -- at market value
(identified cost $420,275,085)........................................... $ 505,807,950
Short-term investments -- at cost plus interest earned
(maturities 60 days or less)............................................. 12,147,473 $ 517,955,423
----------------
Cash......................................................................... 259
Receivable for:
Dividends and accrued interest............................................. $ 900,067
Capital Stock sold......................................................... 95,309
Investment securities sold................................................. 82,431 1,077,807
---------------- ---------------
$ 519,033,489
---------------
LIABILITIES
Payable for:
Capital Stock repurchased.................................................. $ 728,086
Advisory fees and financial services....................................... 320,280
Accrued expenses and other liabilities..................................... 84,996 1,133,362
---------------- ---------------
NET ASSETS .................................................................... $ 517,900,127
---------------
---------------
SUMMARY OF SHAREHOLDERS' EQUITY
Capital Stock -- par value $0.01 per share; authorized
100,000,000 shares; outstanding 15,561,521 shares.......................... $ 155,615
Additional Paid-in Capital................................................... 347,703,815
Undistributed net realized gain on investments............................... 83,912,524
Undistributed net investment income.......................................... 595,308
Unrealized appreciation of investments....................................... 85,532,865
---------------
NET ASSETS................................................................... $ 517,900,127
---------------
---------------
NET ASSET VALUE, REDEMPTION PRICE AND MAXIMUM
OFFERING PRICE PER SHARE
Net asset value and redemption price per share
(net assets divided by shares outstanding).................................. $33.28
------
------
Maximum offering price per share
(100/93.5 of per share net asset value)..................................... $35.59
------
------
</TABLE>
See notes to financial statements.
31
<PAGE>
STATEMENT OF OPERATIONS
For the Year Ended March 31, 2000
<TABLE>
<CAPTION>
INVESTMENT INCOME
<S> <C>
Interest................................................................... $ 2,939,100
Dividends (including $652,228 from securities of affiliates)............... 3,592,761
--------------
$ 6,531,861
<CAPTION>
EXPENSES
<S> <C> <C>
Advisory fees.............................................................. $ 3,538,917
Financial services......................................................... 536,756
Transfer agent fees and expenses........................................... 281,941
Custodian fees and expenses................................................ 48,690
Reports to shareholders.................................................... 39,594
Directors' fees and expenses............................................... 33,913
Postage.................................................................... 32,899
Audit fees................................................................. 29,150
Insurance.................................................................. 28,567
Registration fees.......................................................... 26,775
Legal fees................................................................. 26,255
Other expenses............................................................. 5,854 4,629,311
--------------- --------------
Net investment income.............................................. $ 1,902,550
--------------
<CAPTION>
NET REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
<S> <C> <C>
Net realized gain on investments:
Proceeds from sales of investment securities (excluding
short-term investments with maturities of 60 days or less)............... $ 218,049,704
Cost of investment securities sold......................................... 83,060,579
---------------
Net realized gain on investments....................................... $ 134,989,125
Unrealized appreciation of investments:
Unrealized appreciation at beginning of year............................... $ 104,375,959
Unrealized appreciation at end of year..................................... 85,532,865
---------------
Decrease in unrealized appreciation of investments..................... (18,843,094)
--------------
Net realized and unrealized gain on investments.................... $ 116,146,031
--------------
NET INCREASE IN NET ASSETS RESULTING
FROM OPERATIONS.............................................................. $ 118,048,581
==============
</TABLE>
See notes to financial statements.
32
<PAGE>
<TABLE>
<CAPTION>
STATEMENT OF CHANGES IN NET ASSETS
FOR THE YEAR ENDED MARCH 31,
--------------------------------------------------------------
2000 1999
----------------------------- ------------------------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSETS
Operations:
Net investment income............................ $ 1,902,550 $ 8,040,517
Net realized gain on investments................. 134,989,125 22,184,394
Decrease in unrealized
appreciation of investments.................... (18,843,094) (178,504,438)
Net unrealized appreciation reclassified
on investments redeemed in-kind................ -- 50,764,552
------------- --------------
Increase (decrease) in net assets
resulting from operations........................ $ 118,048,581 $ (97,514,975)
Distributions to shareholders from:
Net investment income............................ $ (3,566,650) $ (8,475,386)
Net realized capital gains....................... (64,562,292) (68,128,942) (67,364,919) (75,840,305)
------------- --------------
Capital Stock transactions:
Proceeds from Capital Stock sold................. $ 41,936,498 $ 112,648,442
Proceeds from shares issued to
shareholders upon reinvestment
of dividends and distributions................. 59,105,054 67,687,754
Cost of Capital Stock repurchased................ (146,955,403) (45,913,851) (282,522,710) (102,186,514)
------------- --------------- -------------- ---------------
Total increase (decrease) in net assets............ $ 4,005,788 $ (275,541,794)
NET ASSETS
Beginning of year, including
undistributed net investment income
of $2,259,408 and $2,694,277..................... 513,894,339 789,436,133
--------------- ---------------
End of year, including undistributed
net investment income
of $595,308 and $2,259,408....................... $ 517,900,127 $ 513,894,339
=============== ===============
CHANGE IN CAPITAL STOCK
OUTSTANDING
Shares of Capital Stock sold....................... 1,301,816 3,365,864
Shares issued to shareholders upon
reinvestment of dividends and
distributions.................................... 1,945,279 1,948,828
Shares of Capital Stock repurchased................ (4,622,194) (8,989,993)
--------------- ---------------
Decrease in Capital
Stock outstanding (1,375,099) (3,675,301)
=============== ===============
</TABLE>
See notes to financial statements.
33
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Continued
NOTE 1 -- SIGNIFICANT ACCOUNTING POLICIES
The Fund is registered under the Investment Company Act of 1940, as a
diversified, open-end investment company. The Fund's primary investment
objective is long-term capital growth. Current income is a factor, but a
secondary consideration. The following is a summary of significant accounting
policies consistently followed by the Fund in the preparation of its financial
statements.
A. Security Valuation
Securities listed or traded on a national securities exchange or on
the NASDAQ National Market System are valued at the last sale price on the
last business day of the year, or if there was not a sale that day, at the
last bid price. Unlisted securities are valued at the most recent bid
price. Short-term investments with maturities of 60 days or less are valued
at cost plus interest earned, which approximates market value.
B. Federal Income Tax
No provision for federal income tax is required because the Fund has
elected to be taxed as a "regulated investment company" under the Internal
Revenue Code and intends to maintain this qualification and to distribute
each year to its shareholders, in accordance with the minimum distribution
requirements of the Code, all of its taxable net investment income and
taxable net realized gains on investments.
C. Securities Transactions and Related Investment Income
Securities transactions are accounted for on the date the securities
are purchased or sold. Dividend income and distributions to shareholders
are recorded on the ex-dividend date. Interest income and expenses are
recorded on an accrual basis.
D. Use of Estimates
The preparation of the financial statements in accordance with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported. Actual results
could differ from those estimates.
NOTE 2 -- PURCHASES OF INVESTMENT SECURITIES
Cost of purchases of investment securities (excluding short-term
investments with maturities of 60 days or less) aggregated $96,339,393 for the
year ended March 31, 2000. Realized gains or losses are based on the
specific-certificate identification method. Cost of securities held at March 31,
2000 was the same for federal income tax and financial reporting purposes. Gross
unrealized appreciation and depreciation for all investments at March 31, 2000
for federal income tax purposes was $179,257,353 and $93,724,488, respectively.
NOTE 3 -- ADVISORY FEES AND OTHER AFFILIATED TRANSACTIONS
Pursuant to an Investment Advisory Agreement, advisory fees were paid by
the Fund to First Pacific Advisors, Inc. (the "Adviser"). Under the terms of
this Agreement, the Fund pays the Adviser a monthly fee calculated at the annual
rate of 0.75% of the first $50 million of the Fund's average daily net assets
and 0.65% of the average daily net assets in excess of $50 million. In addition,
the Fund pays the Adviser an amount equal to 0.1% of the average daily net
assets for each fiscal year in reimbursement for the provision of financial
services to the Fund. The Agreement provides that the Adviser will reimburse the
Fund for any annual expenses (exclusive of interest, taxes, the cost of any
supplemental statistical and research information, and extraordinary expenses
such as litigation) in excess of 1?% of the first $30 million and 1% of the
remaining average net assets of the Fund for the year.
For the year ended March 31, 2000, the Fund paid aggregate fees of $33,280
to all Directors who are not affiliated persons of the Adviser. Legal fees were
for services rendered by O'Melveny & Myers LLP, counsel for the Fund. A Director
of the Fund is of counsel to, and a
34
<PAGE>
NOTES TO FINANCIAL STATEMENTS
Continued
retired partner of, that firm. Certain officers of the Fund are also officers of
the Adviser and FPA Fund Distributors, Inc.
NOTE 4 -- DISTRIBUTOR
For the year ended March 31, 2000, FPA Fund Distributors, Inc.
("Distributor"), a wholly owned subsidiary of the Adviser, received $9,764 in
net Fund share sales commissions after reallowance to other dealers. The
Distributor pays its own overhead and general administrative expenses, the cost
of supplemental sales literature, promotion and advertising.
NOTE 5 -- SALES OF FUND SHARES
Shares of the Fund are presently offered for sale only to existing
shareholders and to directors, officers, and employees of the Fund, the Adviser,
and affiliated companies. The discontinuation of sales to new investors reflects
Management's belief that unrestrained growth in the Fund's net assets might
impair investment flexibility. The Fund may resume at any time the sale of its
shares to new investors if, in the Board of Directors' opinion, doing so would
be in the best interests of the Fund and its shareholders.
35
<PAGE>
REPORT OF INDEPENDENT AUDITORS
TO THE BOARD OF DIRECTORS AND
SHAREHOLDERS OF FPA CAPITAL FUND, INC.
We have audited the accompanying statement of assets and liabilities of FPA
Capital Fund, Inc. (the "Fund"), including the portfolio of investments, as of
March 31, 2000, and the related statement of operations for the year then ended,
the statement of changes in net assets for each of the two years in the period
then ended, and the financial highlights on page 17 of the Prospectus for each
of the five years in the period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements and financial highlights. Our procedures included
confirmation of securities owned as of March 31, 2000, by correspondence with
the custodian and brokers. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements and financial highlights referred to
above present fairly, in all material respects, the financial position of FPA
Capital Fund, Inc. at March 31, 2000, the results of its operations for the year
then ended, the changes in its net assets for each of the two years in the
period then ended, and the financial highlights on page 17 of the Prospectus,
for each of the five years in the period then ended, in conformity with
accounting principles generally accepted in the United States.
/s/ ERNST & YOUNG LLP
ERNST & YOUNG LLP
Los Angeles, California
April 24, 2000
36
