J.P. MORGAN FUNDS
J.P. MORGAN TAX EXEMPT BOND FUND
STATEMENT OF ADDITIONAL INFORMATION
DECEMBER 1, 2000
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS, BUT CONTAINS
ADDITIONAL INFORMATION WHICH SHOULD BE READ IN CONJUNCTION WITH THE FUND'S
PROSPECTUS DATED DECEMBER 1, 2000, AS SUPPLEMENTED FROM TIME TO TIME.
ADDITIONALLY, THIS STATEMENT OF ADDITIONAL INFORMATION INCORPORATES BY REFERENCE
THE FINANCIAL STATEMENTS INCLUDED IN THE SHAREHOLDER REPORT RELATING TO THE FUND
DATED JULY 31, 2000. THE PROSPECTUS AND THE FINANCIAL STATEMENTS INCLUDING THE
INDEPENDENT ACCOUNTANTS' REPORT THEREON, ARE AVAILABLE, WITHOUT CHARGE, UPON
REQUEST FROM FUNDS DISTRIBUTOR, INC., ATTENTION: J.P. MORGAN FUNDS (800)
221-7930.
TABLE OF CONTENTS
PAGE
GENERAL....................................................................1
INVESTMENT OBJECTIVE AND POLICIES..........................................1
INVESTMENT RESTRICTIONS...................................................18
TRUSTEES AND MEMBERS OF THE ADVISORY BOARD................................19
OFFICERS..................................................................22
CODES OF ETHICS...........................................................24
INVESTMENT ADVISOR........................................................24
DISTRIBUTOR...............................................................25
CO-ADMINISTRATOR..........................................................26
SERVICES AGENT............................................................26
CUSTODIAN AND TRANSFER AGENT..............................................27
SHAREHOLDER SERVICING.....................................................27
FINANCIAL PROFESSIONALS...................................................28
INDEPENDENT ACCOUNTANTS...................................................28
EXPENSES..................................................................29
PURCHASE OF SHARES........................................................29
REDEMPTION OF SHARES......................................................29
EXCHANGE OF SHARES........................................................30
DIVIDENDS AND DISTRIBUTIONS...............................................30
NET ASSET VALUE...........................................................31
PERFORMANCE DATA..........................................................31
PORTFOLIO TRANSACTIONS....................................................33
MASSACHUSETTS TRUST.......................................................34
DESCRIPTION OF SHARES.....................................................34
SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE.......................36
TAXES.....................................................................37
ADDITIONAL INFORMATION....................................................39
FINANCIAL STATEMENTS......................................................39
APPENDIX A...............................................................A-1
GENERAL
This Statement of Additional Information relates only to the J.P.
Morgan Tax Exempt Bond Fund (the "Fund"). The Fund is a series of shares of
beneficial interest of the J.P. Morgan Funds, an open-end management investment
company formed as a Massachusetts business trust (the "Trust"). In addition to
the Fund, the Trust consists of other series representing separate investment
funds (each a "J.P. Morgan Fund"). The other J.P. Morgan Funds are covered by
separate Statements of Additional Information.
This Statement of Additional Information describes the financial
history, investment objective and policies, management and operation of the Fund
and provides additional information with respect to the Fund and should be read
in conjunction with the Fund's current Prospectus (the "Prospectus").
Capitalized terms not otherwise defined herein have the meanings accorded to
them in the Prospectus. The Fund's executive offices are located at 60 State
Street, Suite 1300, Boston, Massachusetts 02109.
Unlike other mutual funds which directly acquire and manage their own
portfolio of securities, the Fund seeks to achieve its investment objective by
investing all of its investable assets in The Tax Exempt Bond Portfolio (the
"Portfolio"), a corresponding diversified open-end management investment company
having the same investment objective as the Fund. The Fund invests in the
Portfolio through a two-tier master-feeder investment fund structure. See
"Special Information Concerning Investment Structure."
The Portfolio is advised by J.P. Morgan Investment Management Inc.
("JPMIM" or the "Advisor").
Investments in the Fund are not deposits or obligations of, or
guaranteed or endorsed by, Morgan Guaranty Trust Company of New York ("Morgan"),
an affiliate of the Advisor, or any other bank. Shares of the Fund are not
federally insured by the Federal Deposit Insurance Corporation, the Federal
Reserve Board, or any other governmental agency. An investment in the Fund is
subject to risk that may cause the value of the investment to fluctuate, and
when the investment is redeemed, the value may be higher or lower than the
amount originally invested by the investor.
INVESTMENT OBJECTIVE AND POLICIES
The following discussion supplements the information regarding the
Fund's investment objective and the policies to be employed to achieve this
objective by the Portfolio as set forth above and in the Prospectus. The
investment objective of the Fund and the investment objective of the Portfolio
are identical. Accordingly, references below to the Fund also include the
Portfolio; similarly, references to the Portfolio also include the Fund unless
the context requires otherwise.
The Fund is designed for investors who seek tax exempt yields greater
than those generally available from a portfolio of short term tax exempt
obligations and who are willing to incur the greater price fluctuation of
longer-term instruments. Additionally, the Fund is designed to be an economical
and convenient means of making substantial investments in debt obligations that
are exempt from federal income tax. The Fund's investment objective is to
provide a high level of current income exempt from federal income tax consistent
with moderate risk of capital. See "Taxes." The Fund attempts to achieve its
investment objective by investing all of its investable assets in The Tax Exempt
Bond Portfolio (the "Portfolio"), a diversified open-end management investment
company having the same investment objective as the Fund.
The Fund attempts to achieve its investment objective by investing
primarily in securities of states, territories and possessions of the United
States and their political subdivisions, agencies and instrumentalities, the
interest of which is exempt from federal income tax in the opinion of bond
counsel for the issuer, but it may invest up to 20% of its total assets in
taxable obligations. During normal market conditions, the Fund will invest at
least 80% of its net assets in tax exempt obligations. Interest on these
securities may be subject to state and local taxes. For more detailed
information regarding tax matters, including the applicability of the
alternative minimum tax, see "Taxes". The Fund attempts to invest its assets in
tax exempt municipal securities; however, under certain
circumstances the Fund is permitted to invest up to 20% of the value of its
total assets in securities, the interest income on which may be subject to
federal, state and local income taxes. The Fund will invest in taxable
securities only if there are no tax exempt securities available for purchase or
if the expected return from an investment in taxable securities exceeds the
expected return on available tax exempt securities. In abnormal market
conditions, if, in the judgment of the Advisor, tax exempt securities satisfying
the Fund's investment objective may not be purchased, the Fund may, for
defensive purposes only, temporarily invest more than 20% of its net assets in
debt securities the interest on which is subject to federal, state and local
income taxes. The taxable investments permitted for the Fund include obligations
of the U.S. Government and its agencies and instrumentalities, bank obligations,
commercial paper and repurchase agreements and other debt securities which meet
the Fund's quality requirements. See "Taxes". The Fund seeks to maintain a
current yield that is greater than that obtainable from a portfolio of short
term tax exempt obligations, subject to certain quality restrictions. See
"Quality and Diversification Requirements."
The Advisor believes that based upon current market conditions, the
Fund will consist of a portfolio of securities with a duration of four to seven
years. In view of the duration of the Fund, under normal market conditions, the
Fund's yield can be expected to be higher and its net asset value less stable
than those of a money market fund. Duration is a measure of the weighted average
maturity of the bonds held in the Fund and can be used as a measure of the
sensitivity of the Fund's market value to changes in interest rates. The
maturities of the individual securities in the Fund may vary widely, however, as
the Advisor adjusts the Fund's holdings of long-term and short-term debt
securities to reflect its assessment of prospective changes in interest rates,
which may adversely affect current income.
The value of the Fund's investments will generally fluctuate inversely
with changes in prevailing interest rates. The value of the Fund's investments
will also be affected by changes in the creditworthiness of issuers and other
market factors. The quality criteria applied in the selection of portfolio
securities are intended to minimize adverse price changes due to credit
considerations. The value of the Fund's municipal securities can also be
affected by market reaction to legislative consideration of various tax reform
proposals. Although the net asset value of the Fund fluctuates, the Fund
attempts to preserve the value of its investments to the extent consistent with
its objective.
TAX EXEMPT OBLIGATIONS
The Fund may invest in bonds issued by or on behalf of states,
territories and possessions of the United States and the District of Columbia
and their political subdivisions, agencies, authorities and instrumentalities.
These obligations may be general obligation bonds secured by the issuer's pledge
of its full faith credit and taxing power for the payment of principal and
interest, or they may be revenue bonds payable from specific revenue sources,
but not generally backed by the issuer's taxing power. These include industrial
development bonds where payment is the responsibility of the private industrial
user of the facility financed by the bonds. The Fund may invest more than 25% of
its assets in industrial development bonds, but may not invest more than 25% of
its assets in industrial development bonds in projects of similar type or in the
same state.
The Fund will invest in tax exempt obligations. A description of the
various types of tax exempt obligations which may be purchased by the Fund
appears below. See "Quality and Diversification Requirements."
MUNICIPAL BONDS. Municipal bonds are debt obligations issued by the
states, territories and possessions of the United States and the District of
Columbia, by their political subdivisions and by duly constituted authorities
and corporations. For example, states, territories, possessions and
municipalities may issue municipal bonds to raise funds for various public
purposes such as airports, housing, hospitals, mass transportation, schools,
water and sewer works. They may also issue municipal bonds to refund outstanding
obligations and to meet general operating expenses. Public authorities issue
municipal bonds to obtain funding for privately operated facilities, such as
2
housing and pollution control facilities, for industrial facilities or for water
supply, gas, electricity or waste disposal facilities.
Municipal bonds may be general obligation or revenue bonds. General
obligation bonds are secured by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from revenues derived from particular facilities, from the proceeds of a
special excise tax or from other specific revenue sources. They are not
generally payable from the general taxing power of a municipality.
MUNICIPAL NOTES. The Fund may also invest in municipal notes of various
types, including notes issued in anticipation of receipt of taxes, the proceeds
of the sale of bonds, other revenues or grant proceeds, as well as municipal
commercial paper and municipal demand obligations such as variable rate demand
notes and master demand obligations. The interest rate on variable rate demand
notes is adjustable at periodic intervals as specified in the notes. Master
demand obligations permit the investment of fluctuating amounts at periodically
adjusted interest rates. They are governed by agreements between the municipal
issuer and Morgan acting as agent, for no additional fee. Although master demand
obligations are not marketable to third parties, the Fund considers them to be
liquid because they are payable on demand. There is no specific percentage
limitation on these investments. Municipal notes are subdivided into three
categories of short-term obligations: municipal notes, municipal commercial
paper and municipal demand obligations.
Municipal notes are short-term obligations with a maturity at the time
of issuance ranging from six months to five years. The principal types of
municipal notes include tax anticipation notes, bond anticipation notes, revenue
anticipation notes, grant anticipation notes and project notes. Notes sold in
anticipation of collection of taxes, a bond sale, or receipt of other revenues
are usually general obligations of the issuing municipality or agency.
Municipal commercial paper typically consists of very short-term
unsecured negotiable promissory notes that are sold to meet seasonal working
capital or interim construction financing needs of a municipality or agency.
While these obligations are intended to be paid from general revenues or
refinanced with long-term debt, they frequently are backed by letters of credit,
lending agreements, note repurchase agreements or other credit facility
agreements offered by banks or institutions.
Municipal demand obligations are subdivided into two types: variable
rate demand notes and master demand obligations.
Variable rate demand notes are tax exempt municipal obligations or
participation interests that provide for a periodic adjustment in the interest
rate paid on the notes. They permit the holder to demand payment of the notes,
or to demand purchase of the notes at a purchase price equal to the unpaid
principal balance, plus accrued interest either directly by the issuer or by
drawing on a bank letter of credit or guaranty issued with respect to such note.
The issuer of the municipal obligation may have a corresponding right to prepay
at its discretion the outstanding principal of the note plus accrued interest
upon notice comparable to that required for the holder to demand payment. The
variable rate demand notes in which the Fund may invest are payable, or are
subject to purchase, on demand usually on notice of seven calendar days or less.
The terms of the notes provide that interest rates are adjustable at intervals
ranging from daily to six months, and the adjustments are based upon the prime
rate of a bank or other appropriate interest rate index specified in the
respective notes. Variable rate demand notes are valued at amortized cost; no
value is assigned to the right of the Fund to receive the par value of the
obligation upon demand or notice.
Master demand obligations are tax exempt municipal obligations that
provide for a periodic adjustment in the interest rate paid and permit daily
changes in the amount borrowed. The interest on such obligations is, in the
opinion of counsel for the borrower, excluded from gross income for federal
income tax purposes. Although there is no secondary market for master demand
obligations, such obligations are considered by the Fund to be liquid
3
because they are payable upon demand. The Fund has no specific percentage
limitations on investments in master demand obligations.
PREMIUM SECURITIES. During a period of declining interest rates, many
municipal securities in which the Fund invests likely will bear coupon rates
higher than current market rates, regardless of whether the securities were
initially purchased at a premium. In general, such securities have market values
greater than the principal amounts payable on maturity, which would be reflected
in the net asset value of the Fund's shares. The values of such "premium"
securities tend to approach the principal amount as they near maturity.
PUTS. The Fund may purchase without limit, municipal bonds or notes
together with the right to resell the bonds or notes to the seller at an agreed
price or yield within a specified period prior to the maturity date of the bonds
or notes. Such a right to resell is commonly known as a "put." The aggregate
price for bonds or notes with puts may be higher than the price for bonds or
notes without puts. Consistent with the Fund's investment objective and subject
to the supervision of the Trustees, the purpose of this practice is to permit
the Fund to be fully invested in tax exempt securities while preserving the
necessary liquidity to purchase securities on a when-issued basis, to meet
unusually large redemptions, and to purchase at a later date securities other
than those subject to the put. The principal risk of puts is that the writer of
the put may default on its obligation to repurchase. The Advisor will monitor
each writer's ability to meet its obligations under puts.
Puts may be exercised prior to the expiration date in order to fund
obligations to purchase other securities or to meet redemption requests. These
obligations may arise during periods in which proceeds from sales of Fund shares
and from recent sales of portfolio securities are insufficient to meet
obligations or when the funds available are otherwise allocated for investment.
In addition, puts may be exercised prior to the expiration date in order to take
advantage of alternative investment opportunities or in the event the Advisor
revises its evaluation of the creditworthiness of the issuer of the underlying
security. In determining whether to exercise puts prior to their expiration date
and in selecting which puts to exercise, the Advisor considers the amount of
cash available to the Fund, the expiration dates of the available puts, any
future commitments for securities purchases, alternative investment
opportunities, the desirability of retaining the underlying securities in the
Fund's portfolio and the yield, quality and maturity dates of the underlying
securities.
The Fund values any municipal bonds and notes subject to puts with
remaining maturities of less than 60 days by the amortized cost method. If the
Fund were to invest in municipal bonds and notes with maturities of 60 days or
more that are subject to puts separate from the underlying securities, the puts
and the underlying securities would be valued at fair value as determined in
accordance with procedures established by the Board of Trustees. The Board of
Trustees would, in connection with the determination of the value of a put,
consider, among other factors, the creditworthiness of the writer of the put,
the duration of the put, the dates on which or the periods during which the put
may be exercised and the applicable rules and regulations of the SEC. Prior to
investing in such securities, the Fund, if deemed necessary based upon the
advice of counsel, will apply to the SEC for an exemptive order, which may not
be granted, relating to the valuation of such securities.
Since the value of the put is partly dependent on the ability of the
put writer to meet its obligation to repurchase, the Fund's policy is to enter
into put transactions only with municipal securities dealers who are approved by
the Advisor. Each dealer will be approved on its own merits, and it is the
Fund's general policy to enter into put transactions only with those dealers
which are determined to present minimal credit risks. In connection with such
determination, the Advisor reviews regularly the list of approved dealers,
taking into consideration, among other things, the ratings, if available, of
their equity and debt securities, their reputation in the municipal securities
markets, their net worth, their efficiency in consummating transactions and any
collateral arrangements, such as letters of credit, securing the puts written by
them. Commercial bank dealers normally will be members of the Federal Reserve
System, and other dealers will be members of the National Association of
Securities Dealers, Inc. or members of a national securities exchange. Other put
writers will have outstanding debt
4
rated Aa or better by Moody's Investors Service, Inc. ("Moody's") or AA or
better by Standard & Poor's Ratings Group ("Standard & Poor's"), or will be of
comparable quality in the Advisor's opinion or such put writers' obligations
will be collateralized and of comparable quality in the Advisor's opinion. The
Trustees have directed the Advisor not to enter into put transactions with any
dealer which in the judgment of the Advisor becomes more than a minimal credit
risk. In the event that a dealer should default on its obligation to repurchase
an underlying security, the Fund is unable to predict whether all or any portion
of any loss sustained could subsequently be recovered from such dealer.
Entering into a put with respect to a tax exempt security may be
treated, depending upon the terms of the put, as a taxable sale of the tax
exempt security by the Fund with the result that, while the put is outstanding,
the Fund will no longer be treated as the owner of the security and the interest
income derived with respect to the security will be treated as taxable income to
the Fund.
NON-MUNICIPAL SECURITIES
The Fund may invest in bonds and other debt securities of domestic
issuers to the extent consistent with its investment objective and policies. The
Fund may invest in U.S. Government, bank and corporate debt obligations, as well
as asset-backed securities and repurchase agreements. The Fund will purchase
such securities only when the Advisor believes that they would enhance the after
tax returns of a shareholder of the Fund in the highest federal income tax
brackets. Under normal circumstances, the Fund's holdings of non-municipal
securities will not exceed 20% of its total assets. A description of these
investments appears below. See "Quality and Diversification Requirements." For
information on short-term investments in these securities, see "Money Market
Instruments."
ZERO COUPON, PAY-IN-KIND AND DEFERRED PAYMENT SECURITIES. Zero coupon
securities are securities that are sold at a discount to par value and on which
interest payments are not made during the life of the security. Upon maturity,
the holder is entitled to receive the par value of the security. Pay-in-kind
securities are securities that have interest payable by delivery of additional
securities. Upon maturity, the holder is entitled to receive the aggregate par
value of the securities. The Fund accrues income with respect to zero coupon and
pay-in-kind securities prior to the receipt of cash payments. Deferred payment
securities are securities that remain zero coupon securities until a
predetermined date, at which time the stated coupon rate becomes effective and
interest becomes payable at regular intervals. While interest payments are not
made on such securities, holders of such securities are deemed to have received
"phantom income." Because the Fund will distribute "phantom income" to
shareholders, to the extent that shareholders elect to receive dividends in cash
rather than reinvesting such dividends in additional shares, the Fund will have
fewer assets with which to purchase income producing securities. Zero coupon,
pay-in-kind and deferred payment securities may be subject to greater
fluctuation in value and lesser liquidity in the event of adverse market
conditions than comparably rated securities paying cash interest at regular
interest payment periods.
ASSET-BACKED SECURITIES. Asset-backed securities directly or indirectly
represent a participation interest in, or are secured by and payable from, a
stream of payments generated by particular assets such as motor vehicle or
credit card receivables or other asset-backed securities collateralized by such
assets. Payments of principal and interest may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution unaffiliated with the entities issuing the securities. The
asset-backed securities in which the Fund may invest are subject to the Fund's
overall credit requirements. However, asset-backed securities, in general, are
subject to certain risks. Most of these risks are related to limited interests
in applicable collateral. For example, credit card debt receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts on credit card debt thereby reducing the
balance due. Additionally, if the letter of credit is exhausted, holders of
asset-backed securities may also experience delays in payments or losses if the
full amounts due on underlying sales contracts are not realized. Because
asset-backed securities are relatively new, the market experience in these
5
securities is limited and the market's ability to sustain liquidity through all
phases of the market cycle has not been tested.
MONEY MARKET INSTRUMENTS
The Fund will invest in money market instruments, to the extent
consistent with its investment objective and policies, that meet the quality
requirements described below. Under normal circumstances, the Fund will purchase
these securities to invest temporary cash balances or to maintain liquidity to
meet withdrawals. However, the Fund may also invest in money market instruments
as a temporary defensive measure taken during, or in anticipation of, adverse
market conditions. A description of the various types of money market
instruments that may be purchased by the Fund appears below. Also see "Quality
and Diversification Requirements."
U.S. TREASURY SECURITIES. The Fund may invest in direct obligations of
the U.S. Treasury, including Treasury bills, notes and bonds, all of which are
backed as to principal and interest payments by the full faith and credit of the
United States.
ADDITIONAL U.S. GOVERNMENT OBLIGATIONS. The Fund may invest in
obligations issued or guaranteed by U.S. Government agencies or
instrumentalities. These obligations may or may not be backed by the "full faith
and credit" of the United States. Securities which are backed by the full faith
and credit of the United States include obligations of the Government National
Mortgage Association, the Farmers Home Administration, and the Export-Import
Bank. In the case of securities not backed by the full faith and credit of the
United States, the Fund must look principally to the federal agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States itself in the event the agency or
instrumentality does not meet its commitments. Securities in which the Fund may
invest that are not backed by the full faith and credit of the United States
include, but are not limited to: (i) obligations of the Tennessee Valley
Authority, the Federal Home Loan Mortgage Corporation, the Federal Home Loan
Banks and the U.S. Postal Service, each of which has the right to borrow from
the U.S. Treasury to meet its obligations; (ii) securities issued by the Federal
National Mortgage Association, which are supported by the discretionary
authority of the U.S. Government to purchase the agency's obligations; and (iii)
obligations of the Federal Farm Credit System and the Student Loan Marketing
Association, each of whose obligations may be satisfied only by the individual
credits of the issuing agency.
BANK OBLIGATIONS. The Fund may invest in negotiable certificates of
deposit, time deposits and bankers' acceptances of (i) banks, savings and loan
associations and savings banks which have more than $2 billion in total and are
organized under the laws of the United States or any state, (ii) foreign
branches of these banks (Euros) and (iii) U.S. branches of foreign banks of
equivalent size (Yankees). The Fund may not invest in obligations of foreign
branches of foreign banks. The Fund will not invest in obligations for which the
Advisor, or any of its affiliated persons, is the ultimate obligor or accepting
bank.
COMMERCIAL PAPER. The Fund may invest in commercial paper, including
master demand obligations. For a description of master demand obligations see
"Tax Exempt Obligations - Municipal Notes" above. Master demand obligations are
obligations that provide for a periodic adjustment in the interest rate paid and
permit daily changes in the amount borrowed. Master demand obligations are
governed by agreements between the issuer and Morgan acting as agent, for no
additional fee. The monies loaned to the borrower come from accounts managed by
Morgan or its affiliates, pursuant to arrangements with such accounts. Interest
and principal payments are credited to such accounts. Morgan has the right to
increase or decrease the amount provided to the borrower under an obligation.
The borrower has the right to pay without penalty all or any part of the
principal amount then outstanding on an obligation together with interest to the
date of payment. Since these obligations typically provide that the interest
rate is tied to the Federal Reserve commercial paper composite rate, the rate on
master demand obligations is subject to change. Repayment of a master demand
obligation to participating accounts depends on the ability of the borrower to
pay the accrued interest and principal of the obligation on demand which is
continuously monitored by
6
Morgan. Since master demand obligations typically are not rated by credit rating
agencies, the Fund may invest in such unrated obligations only if at the time of
an investment the obligation is determined by the Advisor to have a credit
quality which satisfies the Fund's quality restrictions. See "Quality and
Diversification Requirements." Although there is no secondary market for master
demand obligations, such obligations are considered by the Fund to be liquid
because they are payable upon demand. It is possible that the issuer of a master
demand obligation could be a client of Morgan to whom Morgan, in its capacity as
a commercial bank, has made a loan.
REPURCHASE AGREEMENTS. The Fund may enter into repurchase agreements
with brokers, dealers or banks that meet the Advisor's credit guidelines. In a
repurchase agreement, the Fund buys a security from a seller that has agreed to
repurchase the same security at a mutually agreed upon date and price. The
resale price normally is in excess of the purchase price, reflecting an agreed
upon interest rate. This interest rate is effective for the period of time the
Fund is invested in the agreement and is not related to the coupon rate on the
underlying security. A repurchase agreement may also be viewed as a fully
collateralized loan of money by the Fund to the seller. The period of these
repurchase agreements will usually be short, from overnight to one week, and at
no time will the Fund invest in repurchase agreements for more than thirteen
months. The securities which are subject to repurchase agreements, however, may
have maturity dates in excess of thirteen months from the effective date of the
repurchase agreement. The Fund will always receive securities as collateral
whose market value is, and during the entire term of the agreement remains, at
least equal to 100% of the dollar amount invested by the Fund in the agreement
plus accrued interest, and the Fund will make payment for such securities only
upon physical delivery or upon evidence of book entry transfer to the account of
the Custodian. If the seller defaults, the Fund might incur a loss if the value
of the collateral securing the repurchase agreement declines and might incur
disposition costs in connection with liquidating the collateral. In addition, if
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon disposal of the collateral by the Fund may be delayed or
limited.
The Fund may make investments in other debt securities, including
without limitation corporate bonds and other obligations described in this
Statement of Additional Information.
ADDITIONAL INVESTMENTS
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase
securities on a when-issued or delayed delivery basis. For example, delivery of
and payment for these securities can take place a month or more after the date
of the purchase commitment. The purchase price and the interest rate payable, if
any, on the securities are fixed on the purchase commitment date or at the time
the settlement date is fixed. The value of such securities is subject to market
fluctuation and for money market instruments and other fixed income securities
no interest accrues to the Fund until settlement takes place. At the time the
Fund makes the commitment to purchase securities on a when-issued or delayed
delivery basis, it will record the transaction, reflect the value each day of
such securities in determining its net asset value and, if applicable, calculate
the maturity for the purposes of average maturity from that date. At the time of
settlement a when-issued security may be valued at less than the purchase price.
To facilitate such acquisitions, the Fund will maintain with the custodian a
segregated account with liquid assets, consisting of cash, U.S. Government
securities or other appropriate securities, in an amount at least equal to such
commitments. On delivery dates for such transactions, the Fund will meet its
obligations from maturities or sales of the securities held in the segregated
account and/or from cash flow. If the Fund chooses to dispose of the right to
acquire a when-issued security prior to its acquisition, it could, as with the
disposition of any other portfolio obligation, incur a gain or loss due to
market fluctuation. Also, the Fund may be disadvantaged if the other party to
the transaction defaults.
INVESTMENT COMPANY SECURITIES. Securities of other investment companies
may be acquired by the Fund to the extent permitted under the 1940 Act or any
order pursuant thereto. These limits currently require that, as determined
immediately after a purchase is made, (i) not more than 5% of the value of the
Fund's total assets will be invested in the securities of any one investment
company, (ii) not more than 10% of the value of its total assets will
7
be invested in the aggregate in securities of investment companies as a group,
and (iii) not more than 3% of the outstanding voting stock of any one investment
company will be owned by the Fund, provided however, that the Fund may invest
all of its investable assets in an open-end investment company that has the same
investment objective as the Fund and its Portfolio. As a shareholder of another
investment company, the Fund or Portfolio would bear, along with other
shareholders, its pro rata portion of the other investment company's expenses,
including advisory fees. These expenses would be in addition to the advisory and
other expenses that the Fund or Portfolio bears directly in connection with its
own operations.
The Securities and Exchange Commission ("SEC") has granted the
Portfolios an exemptive order permitting it to invest its uninvested cash in any
of the following affiliated money market funds: J.P. Morgan Institutional Prime
Money Market Fund, J.P. Morgan Institutional Tax Exempt Money Market Fund, J.P.
Morgan Institutional Federal Money Market Fund and J.P. Morgan Institutional
Treasury Money Market Fund. The order sets forth the following conditions: (1)
the Portfolio may invest in one or more of the permitted money market funds up
to an aggregate limit of 25% of its assets; and (2) the Advisor will waive
and/or reimburse its advisory fee from the Portfolio in an amount sufficient to
offset any doubling up of investment advisory, shareholder servicing and
administrative fees.
REVERSE REPURCHASE AGREEMENTS. The Fund may enter into reverse
repurchase agreements. In a reverse repurchase agreement, a Fund sells a
security and agrees to repurchase the same security at a mutually agreed upon
date and price reflecting the interest rate effective for the term of the
agreement. For purposes of the 1940 Act a reverse repurchase agreement is also
considered as the borrowing of money by the Fund and, therefore, a form of
leverage. Leverage may cause any gains or losses for the Fund to be magnified.
The Fund will invest the proceeds of borrowings under reverse repurchase
agreements. In addition, except for liquidity purposes, the Fund will enter into
a reverse repurchase agreement only when the expected return from the investment
of the proceeds is greater than the expense of the transaction. The Fund will
not invest the proceeds of a reverse repurchase agreement for a period which
exceeds the duration of the reverse repurchase agreement. The Fund will
establish and maintain with the custodian a separate account with a segregated
portfolio of securities in an amount at least equal to its purchase obligations
under its reverse repurchase agreements. All forms of borrowing (including
reverse repurchase agreements and securities lending) are limited in the
aggregate and may not exceed 33-1/3% of the Fund's total assets.
LOANS OF PORTFOLIO SECURITIES. The Fund may lend its securities if such
loans are secured continuously by cash or equivalent collateral or by a letter
of credit in favor of the Fund at least equal at all times to 100% of the market
value of the securities loaned, plus accrued interest. While such securities are
on loan, the borrower will pay the Fund any income accruing thereon. Loans will
be subject to termination by the Fund in the normal settlement time, generally
three business days after notice, or by the borrower on one day's notice.
Borrowed securities must be returned when the loan is terminated. Any gain or
loss in the market price of the borrowed securities which occurs during the term
of the loan inures to the Fund and its respective investors. The Fund may pay
reasonable finders' and custodial fees in connection with a loan. In addition,
the Fund will consider all facts and circumstances including the
creditworthiness of the borrowing financial institution, the Fund will not make
any loans in excess of one year. The Fund will not lend its securities to any
officer, Trustee, Member of the Advisory Board, Director, employee or other
affiliate of the Fund, the Advisor or the Distributor, unless otherwise
permitted by applicable law. All forms of borrowing (including reverse
repurchase agreements and securities lending) are limited in the aggregate and
may not exceed 33-1/3% of the Fund's total assets.
ILLIQUID INVESTMENTS; PRIVATELY PLACED AND OTHER UNREGISTERED
SECURITIES. The Fund may not acquire any illiquid securities if, as a result
thereof, more than 15% of the Fund's net assets would be in illiquid
investments. Subject to this non-fundamental policy limitation, the Fund may
acquire investments that are illiquid or have limited liquidity, such as private
placements or investments that are not registered under the Securities Act of
1933, as amended (the "1933 Act"), and cannot be offered for public sale in the
United States without first being
8
registered under the 1933 Act. An illiquid investment is any investment that
cannot be disposed of within seven days in the normal course of business at
approximately the amount at which it is valued by the Portfolio. The price the
Fund pays for illiquid securities or receives upon resale may be lower than the
price paid or received for similar securities with a more liquid market.
Accordingly the valuation of these securities will reflect any limitations on
their liquidity.
The Fund may also purchase Rule 144A securities sold to institutional
investors without registration under the 1933 Act. These securities may be
determined to be liquid in accordance with guidelines established by the Advisor
and approved by the Trustees. The Trustees will monitor the Advisor's
implementation of these guidelines on a periodic basis.
As to illiquid investments, the Fund is subject to a risk that should
the Fund decide to sell them when a ready buyer is not available at a price the
Fund deems representative of their value, the value of the Fund's net assets
could be adversely affected. Where an illiquid security must be registered under
the 1933 Act, before it may be sold, the Fund may be obligated to pay all or
part of the registration expenses, and a considerable period may elapse between
the time of the decision to sell and the time the Fund may be permitted to sell
a security under an effective registration statement. If, during such a period,
adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell.
SYNTHETIC VARIABLE RATE INSTRUMENTS. The Fund may invest in certain
synthetic variable rate instruments. Such instruments generally involve the
deposit of a long-term tax exempt bond in a custody or trust arrangement and the
creation of a mechanism to adjust the long-term interest rate on the bond to a
variable short-term rate and a right (subject to certain conditions) on the part
of the purchaser to tender it periodically to a third party at par. Morgan will
review the structure of synthetic variable rate instruments to identify credit
and liquidity risks (including the conditions under which the right to tender
the instrument would no longer be available) and will monitor those risks. In
the event that the right to tender the instrument is no longer available, the
risk to the Fund will be that of holding the long-term bond. In the case of some
types of instruments credit enhancement is not provided, and if certain events,
which may include (a) default in the payment of principal or interest on the
underlying bond, (b) downgrading of the bond below investment grade or (c) a
loss of the bond's tax exempt status, occur, then (i) the put will terminate and
(ii) the risk to the Fund will be that of holding a long-term bond.
QUALITY AND DIVERSIFICATION REQUIREMENTS
The Fund intends to meet the diversification requirements of the 1940
Act. Current 1940 Act diversification requirements require that with respect to
75% of the assets of the Fund: (1) the Fund may not invest more than 5% of its
total assets in the securities of any one issuer, except obligations of the U.S.
Government, its agencies and instrumentalities, and (2) the Fund may not own
more than 10% of the outstanding voting securities of any one issuer. As for the
other 25% of the Fund's assets not subject to the limitation described above,
there is no limitation on investment of these assets under the 1940 Act, so that
all of such assets may be invested in securities of any one issuer. Investments
not subject to the limitations described above could involve an increased risk
to the Fund should an issuer, or a state or its related entities, be unable to
make interest or principal payments or should the market value of such
securities decline.
The Fund will comply with the diversification requirements imposed by
the Internal Revenue Code of 1986, as amended (the "Code"), for qualification as
a regulated investment company. See "Taxes."
The Fund, for purposes of diversification and concentration under the
1940 Act, identification of the issuer of municipal bonds or notes depends on
the terms and conditions of the obligation. If the assets and revenues of an
agency, authority, instrumentality or other political subdivision are separate
from those of the government creating the subdivision and the obligation is
backed only by the assets and revenues of the subdivision, such subdivision is
9
regarded as the sole issuer. Similarly, in the case of an industrial development
revenue bond or pollution control revenue bond, if the bond is backed only by
the assets and revenues of the nongovernmental user, the nongovernmental user is
regarded as the sole issuer. If in either case the creating government or
another entity guarantees an obligation, the guaranty is regarded as a separate
security and treated as an issue of such guarantor. Since securities issued or
guaranteed by states or municipalities are not voting securities, there is no
limitation on the percentage of a single issuer's securities which the Fund may
own so long as it does not invest more than 5% of its total assets that are
subject to the diversification limitation in the securities of such issuer,
except obligations issued or guaranteed by the U.S. Government. Consequently,
the Fund may invest in a greater percentage of the outstanding securities of a
single issuer than would an investment company which invests in voting
securities. See "Investment Restrictions."
It is the current policy of the Fund that under normal circumstances at
least 90% of total assets will consist of securities that at the time of
purchase are rated Baa or better by Moody's or BBB or better by Standard &
Poor's. The remaining 10% of total assets may be invested in securities that are
rated B or better by Moody's or Standard & Poor's. See "Below Investment Grade
Debt" below. In each case, the Fund may invest in securities which are unrated,
if in the Advisor's opinion, such securities are of comparable quality.
Securities rated Baa by Moody's or BBB by Standard & Poor's are considered
investment grade, but have some speculative characteristics. Securities rated Ba
or B by Moody's and BB or B by Standard & Poor's are below investment grade and
considered to be speculative with regard to payment of interest and principal.
These standards must be satisfied at the time an investment is made. If the
quality of the investment later declines, the Fund may continue to hold the
investment.
The Portfolio invests principally in a diversified portfolio of
"investment grade" tax exempt securities. On the date of investment, with
respect to at least 90% of its total assets, (i) municipal bonds must be rated
within the four highest ratings of Moody's, currently Aaa, Aa, A and Baa, or of
Standard & Poor's, currently AAA, AA, A and BBB, (ii) municipal notes must be
rated MIG-1 by Moody's or SP-1 by Standard & Poor's (or, in the case of New York
State municipal notes, MIG-1 or MIG-2 by Moody's or SP-1 or SP-2 by Standard &
Poor's) and (iii) at the time the Portfolio invests in any commercial paper,
bank obligation, repurchase agreement, or any other money market instruments,
the investment must have received a short term rating of investment grade or
better (currently Prime-3 or better by Moody's or A-3 or better by Standard &
Poor's) or the investment must have been issued by an issuer that received a
short term investment grade rating or better with respect to a class of
investments or any investment within that class that is comparable in priority
and security with the investment being purchased by the Portfolio. If no such
ratings exists, the investment must be of comparable investment quality in the
Advisor's opinion, but will not be eligible for purchase if the issuer or its
parent has long term outstanding debt rated below BBB. With respect to the
remaining 10% of its assets, any investment must be rated B or better by Moody's
or Standard & Poor's, or of comparable quality. The Portfolio may invest in
other tax exempt securities which are not rated if, in the opinion of the
Advisor, such securities are of comparable quality to the rated securities
discussed above. In addition, at the time the Portfolio invests in any
commercial paper, bank obligation or repurchase agreement, the issuer must have
outstanding debt rated A or higher by Moody's or Standard & Poor's, the issuer's
parent corporation, if any, must have outstanding commercial paper rated Prime-1
by Moody's or A-1 by Standard & Poor's, or if no such ratings are available, the
investment must be of comparable quality in the Advisor's opinion.
BELOW INVESTMENT GRADE DEBT. Certain lower rated securities purchased
by the Fund, such as those rated Ba or B by Moody's or BB or B by Standard &
Poor's (commonly known as junk bonds), may be subject to certain risks with
respect to the issuing entity's ability to make scheduled payments of principal
and interest and to greater market fluctuations. While generally providing
greater income than investments in higher quality securities, lower quality
fixed income securities involve greater risk of loss of principal and income,
including the possibility of default or bankruptcy of the issuers of such
securities, and have greater price volatility, especially during periods of
economic uncertainty or change. These lower quality fixed income securities tend
to be affected by economic changes and short-term corporate and industry
developments to a greater extent than higher quality securities, which react
primarily to fluctuations in the general level of interest rates. To the extent
that the Fund invests in such lower
10
quality securities, the achievement of its investment objective may be more
dependent on the Advisor's own credit analysis.
Lower quality fixed income securities are affected by the market's
perception of their credit quality, especially during times of adverse
publicity, and the outlook for economic growth. Economic downturns or an
increase in interest rates may cause a higher incidence of default by the
issuers of these securities, especially issuers that are highly leveraged. The
market for these lower quality fixed income securities is generally less liquid
than the market for investment grade fixed income securities. It may be more
difficult to sell these lower rated securities to meet redemption requests, to
respond to changes in the market, or to value accurately the Fund's portfolio
securities for purposes of determining the Fund's net asset value. See Appendix
A for more detailed information on these ratings.
In determining suitability of investment in a particular unrated
security, the Advisor takes into consideration asset and debt service coverage,
the purpose of the financing, history of the issuer, existence of other rated
securities of the issuer, and other relevant conditions, such as comparability
to other issuers.
OPTIONS AND FUTURES TRANSACTIONS
The Fund may purchase and sell (a) exchange traded and over-the-counter
(OTC) put and call options on fixed income securities, indexes of fixed income
securities and futures contracts on fixed income securities and indexes of fixed
income securities and (b) futures contracts on fixed income securities and
indexes of fixed income securities. Each of these instruments is a derivative
instrument as its value derives from the underlying asset or index.
The Fund may use futures contracts and options for hedging and risk
management purposes. The Fund may not use futures and options for speculation.
The Fund may utilize options and futures contracts to manage its
exposure to changing interest rates and/or security prices. Some options and
futures strategies, including selling futures contracts and buying puts, tend to
hedge the Fund's investments against price fluctuations. Other strategies,
including buying futures contracts, writing puts and calls and buying calls,
tend to increase market exposure. Options and futures contracts may be combined
with each other or with forward contracts in order to adjust the risk and return
characteristics of the Fund's overall strategy in a manner deemed appropriate to
the Advisor and consistent with the Fund's objective and policies. Because
combined options positions involve multiple trades, they result in higher
transaction costs and may be more difficult to open and close out.
The use of options and futures is a highly specialized activity which
involves investment strategies and risks different from those associated with
ordinary portfolio securities transactions, and there can be no guarantee that
their use will increase the Fund's return. While the use of these instruments by
the Fund may reduce certain risks associated with owning its portfolio
securities, these techniques themselves entail certain other risks. If the
Advisor applies a strategy at an inappropriate time or judges market conditions
or trends incorrectly, options and futures strategies may lower the Fund's
return. Certain strategies limit the Fund's possibilities to realize gains as
well as limiting its exposure to losses. The Fund could also experience losses
if the prices of its options and futures positions were poorly correlated with
its other investments, or if it could not close out its positions because of an
illiquid secondary market. In addition, the Fund will incur transaction costs,
including trading commissions and option premiums, in connection with its
futures and options transactions and these transactions could significantly
increase the Fund's turnover rate.
The Fund may purchase put and call options on securities, indexes of
securities and futures contracts, or purchase and sell futures contracts, only
if such options are written by other persons and if (i) the aggregate
11
premiums paid on all such options which are held at any time do not exceed 20%
of the Fund's net assets, and (ii) the aggregate margin deposits required on all
such futures or options thereon held at any time do not exceed 5% of the Fund's
total assets. In addition, the Fund will not purchase or sell (write) futures
contracts, options on futures contracts or commodity options for risk management
purposes if, as a result, the aggregate initial margin and options premiums
required to establish these positions exceed 5% of the net asset value of the
Fund.
OPTIONS
PURCHASING PUT AND CALL OPTIONS. By purchasing a put option, the Fund
obtains the right (but not the obligation) to sell the instrument underlying the
option at a fixed strike price. In return for this right, the Fund pays the
current market price for the option (known as the option premium). Options have
various types of underlying instruments, including specific securities, indexes
of securities, indexes of securities prices, and futures contracts. The Fund may
terminate its position in a put option it has purchased by allowing it to expire
or by exercising the option. The Fund may also close out a put option position
by entering into an offsetting transaction, if a liquid market exits. If the
option is allowed to expire, the Fund will lose the entire premium it paid. If
the Fund exercises a put option on a security, it will sell the instrument
underlying the option at the strike price. If the Fund exercises an option on an
index, settlement is in cash and does not involve the actual sale of securities.
If an option is American style, it may be exercised on any day up to its
expiration date. A European style option may be exercised only on its expiration
date.
The buyer of a typical put option can expect to realize a gain if the
underlying instrument falls substantially. However, if the price of the
instrument underlying the option does not fall enough to offset the cost of
purchasing the option, a put buyer can expect to suffer a loss (limited to the
amount of the premium paid, plus related transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the instrument underlying the option at the option's
strike price. A call buyer typically attempts to participate in potential price
increases of the instrument underlying the option with risk limited to the cost
of the option if security prices fall. At the same time, the buyer can expect to
suffer a loss if security prices do not rise sufficiently to offset the cost of
the option.
SELLING (WRITING) PUT AND CALL OPTIONS. When the Fund writes a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for the receipt of the premium, the Fund assumes the
obligation to pay the strike price for the instrument underlying the option if
the other party to the option chooses to exercise it. The Fund may seek to
terminate its position in a put option it writes before exercise by purchasing
an offsetting option in the market at its current price. If the market is not
liquid for a put option the Fund has written, however, the Fund must continue to
be prepared to pay the strike price while the option is outstanding, regardless
of price changes, and must continue to post margin as discussed below.
If the price of the underlying instrument rises, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received. If security prices remain the same over time, it is
likely that the writer will also profit, because it should be able to close out
the option at a lower price. If security prices fall, the put writer would
expect to suffer a loss. This loss should be less than the loss from purchasing
and holding the underlying instrument directly, however, because the premium
received for writing the option should offset a portion of the decline.
Writing a call option obligates the Fund to sell or deliver the
option's underlying instrument in return for the strike price upon exercise of
the option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. Through receipt of the option
premium a call writer offsets part of the effect of a price decline. At the same
time, because a
12
call writer must be prepared to deliver the underlying instrument in return for
the strike price, even if its current value is greater, a call writer gives up
some ability to participate in security price increases.
The writer of an exchange traded put or call option on a security, an
index of securities or a futures contract is required to deposit cash or
securities or a letter of credit as margin and to make mark to market payments
of variation margin as the position becomes unprofitable.
OPTIONS ON INDEXES. The Fund may purchase or sell put and call options
on any securities index based on securities in which the Fund may invest.
Options on securities indexes are similar to options on securities, except that
the exercise of securities index options is settled by cash payment and does not
involve the actual purchase or sale of securities. In addition, these options
are designed to reflect price fluctuations in a group of securities or segment
of the securities market rather than price fluctuations in a single security.
The Fund, in purchasing or selling index options, is subject to the risk that
the value of its portfolio securities may not change as much as index because
the Fund's investments generally will not match the composition of an index.
For a number of reasons, a liquid market may not exist and thus the
Fund may not be able to close out an option position that it has previously
entered into. When the Fund purchases an OTC option, it will be relying on its
counterparty to perform its obligations, and the Fund may incur additional
losses if the counterparty is unable to perform.
EXCHANGE TRADED AND OTC OPTIONS. All options purchased or sold by the
Fund will be traded on a securities exchange or will be purchased or sold by
securities dealers (OTC options) that meet creditworthiness standards approved
by the Advisor. While exchange-traded options are obligations of the Options
Clearing Corporation, in the case of OTC options, the Fund relies on the dealer
from which it purchased the option to perform if the option is exercised. Thus,
when the Fund purchases an OTC option, it relies on the dealer from which it
purchased the option to make or take delivery of the underlying securities.
Failure by the dealer to do so would result in the loss of the premium paid by
the Fund as well as loss of the expected benefit of the transaction.
Provided that the Fund has arrangements with certain qualified dealers
who agree that the Fund may repurchase any option it writes for a maximum price
to be calculated by a predetermined formula, the Fund may treat the underlying
securities used to cover written OTC options as liquid. In these cases, the OTC
option itself would only be considered illiquid to the extent that the maximum
repurchase price under the formula exceeds the intrinsic value of the option.
FUTURES CONTRACTS
The Fund may purchase and sell futures contracts. When the Fund
purchases a futures contract, it agrees to purchase a specified quantity of an
underlying instrument at a specified future date or to make a cash payment based
on the value of a securities index. When the Fund sells a futures contract, it
agrees to sell a specified quantity of the underlying instrument at a specified
future date or to receive a cash payment based on the value of a securities
index. The price at which the purchase and sale will take place is fixed when
the Fund enters into the contract. Futures can be held until their delivery
dates or the position can be (and normally is) closed out before then. There is
no assurance, however, that a liquid market will exist when the Fund wishes to
close out a particular position.
When the Fund purchases a futures contract, the value of the futures
contract tends to increase and decrease in tandem with the value of its
underlying instrument. Therefore, purchasing futures contracts will tend to
increase the Fund's exposure to positive and negative price fluctuations in the
underlying instrument, much as if it had purchased the underlying instrument
directly. When the Fund sells a futures contract, by contrast, the value of its
futures position will tend to move in a direction contrary to the value of the
underlying instrument. Selling futures
13
contracts, therefore, will tend to offset both positive and negative market
price changes, much as if the underlying instrument had been sold.
The purchaser or seller of a futures contract is not required to
deliver or pay for the underlying instrument unless the contract is held until
the delivery date. However, when the Fund buys or sells a futures contract it
will be required to deposit "initial margin" with its Custodian in a segregated
account in the name of its futures broker, known as a futures commission
merchant (FCM). Initial margin deposits are typically equal to a small
percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments equal to the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of this amount. The Fund may be
obligated to make payments of variation margin at a time when it is
disadvantageous to do so. Furthermore, it may not always be possible for the
Fund to close out its futures positions. Until it closes out a futures position,
the Fund will be obligated to continue to pay variation margin. Initial and
variation margin payments do not constitute purchasing on margin for purposes of
the Fund's investment restrictions. In the event of the bankruptcy of an FCM
that holds margin on behalf of the Fund, the Fund may be entitled to return of
margin owed to it only in proportion to the amount received by the FCM's other
customers, potentially resulting in losses to the Fund.
The Fund will segregate liquid assets in connection with its use of
options and futures contracts to the extent required by the staff of the
Securities and Exchange Commission. Securities held in a segregated account
cannot be sold while the futures contract or option is outstanding. Unless they
are replaced with other suitable assets. As a result, there is a possibility
that segregation of a large percentage of the Fund's assets could impede
portfolio management or the Fund's ability to meet redemption requests or other
current obligations.
OPTIONS ON FUTURES CONTRACTS. The Fund may purchase and sell (write)
put and call options, including put and call options on futures contracts.
Futures contracts obligate the buyer to take and the seller to make delivery at
a future date of a specified quantity of a financial instrument or an amount of
cash based on the value of a securities index. Currently, futures contracts are
available on various types of fixed income securities, including but not limited
to U.S. Treasury bonds, notes and bills, Eurodollar certificates of deposit and
on indexes of fixed income securities.
Unlike a futures contract, which requires the parties to buy and sell a
security or make a cash settlement payment based on changes in a financial
instrument or securities index on an agreed date, an option on a futures
contract entitles its holder to decide on or before a future date whether to
enter into such a contract. If the holder decides not to exercise its option,
the holder may close out the option position by entering into an offsetting
transaction or may decide to let the option expire and forfeit the premium
thereon. The purchaser of an option on a futures contract pays a premium for the
option but makes no initial margin payments or daily payments of cash in the
nature of "variation" margin payments to reflect the change in the value of the
underlying contract as does a purchaser or seller of a futures contract.
The seller of an option on a futures contract receives the premium paid
by the purchaser and may be required to pay initial margin. Amounts equal to the
initial margin and any additional collateral required on any options on futures
contracts sold by the Fund are paid by the Fund into a segregated account, in
the name of the FCM, as required by the 1940 Act and the SEC's interpretations
thereunder.
COMBINED POSITIONS. The Fund may purchase and write options in
combination with each other, or in combination with futures or forward
contracts, to adjust the risk and return characteristics of the overall
position. For example, the Fund may purchase a put option and write a call
option on the same underlying instrument, in order to construct a combined
position whose risk and return characteristics are similar to selling a futures
contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option
14
at a lower price, in order to reduce the risk of the written call option in the
event of a substantial price increase. Because combined options positions
involve multiple trades, they result in higher transaction costs and may be more
difficult to open and close out.
CORRELATION OF PRICE CHANGES. Because there are a limited number of
types of exchange-traded options and futures contracts, it is likely that the
standardized options and futures contracts available will not match the Fund's
current or anticipated investments exactly. The Fund may invest in options and
futures contracts based on securities with different issuers, maturities, or
other characteristics from the securities in which it typically invests, which
involves a risk that the options or futures position will not track the
performance of the Fund's other investments.
Options and futures contracts prices can also diverge from the prices
of their underlying instruments, even if the underlying instruments match the
Fund's investments well. Options and futures contracts prices are affected by
such factors as current and anticipated short term interest rates, changes in
volatility of the underlying instrument, and the time remaining until expiration
of the contract, which may not affect security prices the same way. Imperfect
correlation may also result from differing levels of demand in the options and
futures markets and the securities markets, from structural differences in how
options and futures and securities are traded, or from imposition of daily price
fluctuation limits or trading halts. The Fund may purchase or sell options and
futures contracts with a greater or lesser value than the securities it wishes
to hedge or intends to purchase in order to attempt to compensate for
differences in volatility between the contract and the securities, although this
may not be successful in all cases. If price changes in the Fund's options or
futures positions are poorly correlated with its other investments, the
positions may fail to produce anticipated gains or result in losses that are not
offset by gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS. There is no assurance that
a liquid market will exist for any particular option or futures contract at any
particular time even if the contract is traded on an exchange. In addition,
exchanges may establish daily price fluctuation limits for options and futures
contracts and may halt trading if a contract's price moves up or down more than
the limit in a given day. On volatile trading days when the price fluctuation
limit is reached or a trading halt is imposed, it may be impossible for the Fund
to enter into new positions or close out existing positions. If the market for a
contract is not liquid because of price fluctuation limits or otherwise, it
could prevent prompt liquidation of unfavorable positions, and could potentially
require the Fund to continue to hold a position until delivery or expiration
regardless of changes in its value. As a result, the Fund's access to other
assets held to cover its options or futures positions could also be impaired.
(See "Exchange Traded and OTC Options" above for a discussion of the liquidity
of options not traded on an exchange.)
POSITION LIMITS. Futures exchanges can limit the number of futures and
options on futures contracts that can be held or controlled by an entity. If an
adequate exemption cannot be obtained, the Fund or the Advisor may be required
to reduce the size of its futures and options positions or may not be able to
trade a certain futures or options contract in order to avoid exceeding such
limits.
ASSET COVERAGE FOR FUTURES CONTRACTS AND OPTIONS POSITIONS. Although
the Fund will not be a commodity pool, certain derivatives subject the Fund to
the rules of the Commodity Futures Trading Commission which limit the extent to
which the Fund can invest in such derivatives. The Fund may invest in futures
contracts and options with respect thereto for hedging purposes without limit.
However, the Fund may not invest in such contracts and options for other
purposes if the sum of the amount of initial margin deposits and premiums paid
for unexpired options with respect to such contracts, other than for bona fide
hedging purposes, exceeds 5% of the liquidation value of the Fund's assets,
after taking into account unrealized profits and unrealized losses on such
contracts and options; provided, however, that in the case of an option that is
in-the-money at the time of purchase, the in-the-money amount may be excluded in
calculating the 5% limitation.
15
In addition, the Fund will comply with guidelines established by the
SEC with respect to coverage of options and futures contracts by mutual funds,
and if the guidelines so require, will set aside appropriate liquid assets in a
segregated custodial account in the amount prescribed. Securities held in a
segregated account cannot be sold while the futures contract or option is
outstanding, unless they are replaced with other suitable assets. As a result,
there is a possibility that segregation of a large percentage of the Fund's
assets could impede portfolio management or a Fund's ability to meet redemption
requests or other current obligations.
SWAPS AND RELATED SWAP PRODUCTS. The Fund may engage in swap
transactions, including, but not limited to, interest rate, currency, securities
index, basket, specific security and commodity swaps, interest rate caps, floors
and collars and options on interest rate swaps (collectively defined as "swap
transactions").
The Fund may enter into swap transactions for any legal purpose
consistent with its investment objective and policies, such as for the purpose
of attempting to obtain or preserve a particular return or spread at a lower
cost than obtaining that return or spread through purchases and/or sales of
instruments in cash markets, to protect against currency fluctuations, as a
duration management technique, to protect against any increase in the price of
securities the Fund anticipates purchasing at a later date, or to gain exposure
to certain markets in the most economical way possible. The Fund will not sell
interest rate caps, floors or collars if it does not own securities with coupons
which provide the interest that a Fund may be required to pay.
Swap agreements are two-party contracts entered into primarily by
institutional counterparties for periods ranging from a few weeks to several
years. In a standard swap transaction, two parties agree to exchange the returns
(or differentials in rates of return) that would be earned or realized on
specified notional investments or instruments. The gross returns to be exchanged
or "swapped" between the parties are calculated by reference to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency or
commodity, or in a "basket" of securities representing a particular index. The
purchaser of an interest rate cap or floor, upon payment of a fee, has the right
to receive payments (and the seller of the cap is obligated to make payments) to
the extent a specified interest rate exceeds (in the case of a cap) or is less
than (in the case of a floor) a specified level over a specified period of time
or at specified dates. The purchaser of an interest rate collar, upon payment of
a fee, has the right to receive payments (and the seller of the collar is
obligated to make payments) to the extent that a specified interest rate falls
outside an agreed upon range over a specified period of time or at specified
dates. The purchaser of an option on an interest rate swap, upon payment of a
fee (either at the time of purchase or in the form of higher payments or lower
receipts within an interest rate swap transaction) has the right, but not the
obligation, to initiate a new swap transaction of a pre-specified notional
amount with pre-specified terms with the seller of the option as the
counterparty.
The "notional amount" of a swap transaction is the agreed upon basis
for calculating the payments that the parties have agreed to exchange. For
example, one swap counterparty may agree to pay a floating rate of interest
(e.g., 3 month LIBOR) calculated based on a $10 million notional amount on a
quarterly basis in exchange for receipt of payments calculated based on the same
notional amount and a fixed rate of interest on a semi-annual basis. In the
event the Fund is obligated to make payments more frequently than it receives
payments from the other party, it will incur incremental credit exposure to that
swap counterparty. This risk may be mitigated somewhat by the use of swap
agreements which call for a net payment to be made by the party with the larger
payment obligation when the obligations of the parties fall due on the same
date. Under most swap agreements entered into by the Fund, payments by the
parties will be exchanged on a "net basis", and the Fund will receive or pay, as
the case may be, only the net amount of the two payments.
The amount of the Fund's potential gain or loss on any swap transaction
is not subject to any fixed limit. Nor is there any fixed limit on the Fund's
potential loss if it sells a cap or collar. If the Fund buys a cap, floor or
collar, however, the Fund's potential loss is limited to the amount of the fee
that it has paid. When measured against
16
the initial amount of cash required to initiate the transaction, which is
typically zero in the case of most conventional swap transactions, swaps, caps,
floors and collars tend to be more volatile than many other types of
instruments.
The use of swap transactions, caps, floors and collars involves
investment techniques and risks which are different from those associated with
portfolio security transactions. If the Advisor is incorrect in its forecasts of
market values, interest rates, and other applicable factors, the investment
performance of the Fund will be less favorable than if these techniques had not
been used. These instruments are typically not traded on exchanges. Accordingly,
there is a risk that the other party to certain of these instruments will not
perform its obligations to the Fund or that the Fund may be unable to enter into
offsetting positions to terminate its exposure or liquidate its position under
certain of these instruments when it wishes to do so. Such occurrences could
result in losses to the Fund.
The Advisor will, however, consider such risks and will enter into swap
and other derivatives transactions only when it believes that the risks are not
unreasonable.
The Fund will maintain cash or liquid assets in a segregated account
with its custodian in an amount sufficient at all times to cover its current
obligations under its swap transactions, caps, floors and collars. If the Fund
enters into a swap agreement on a net basis, it will segregate assets with a
daily value at least equal to the excess, if any, of the Fund's accrued
obligations under the swap agreement over the accrued amount the Fund is
entitled to receive under the agreement. If the Fund enters into a swap
agreement on other than a net basis, or sells a cap, floor or collar, it will
segregate assets with a daily value at least equal to the full amount of a
Fund's accrued obligations under the agreement.
The Fund will not enter into any swap transaction, cap, floor, or
collar, unless the counterparty to the transaction is deemed creditworthy by the
Advisor. If a counterparty defaults, the Fund may have contractual remedies
pursuant to the agreements related to the transaction. The swap markets in which
many types of swap transactions are traded have grown substantially in recent
years, with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a result,
the markets for certain types of swaps (e.g., interest rate swaps) have become
relatively liquid. The markets for some types of caps, floors and collars are
less liquid.
The liquidity of swap transactions, caps, floors and collars will be as
set forth in guidelines established by the Advisor and approved by the Trustees
which are based on various factors, including (1) the availability of dealer
quotations and the estimated transaction volume for the instrument, (2) the
number of dealers and end users for the instrument in the marketplace, (3) the
level of market making by dealers in the type of instrument, (4) the nature of
the instrument (including any right of a party to terminate it on demand) and
(5) the nature of the marketplace for trades (including the ability to assign or
offset the Fund's rights and obligations relating to the instrument). Such
determination will govern whether the instrument will be deemed within the 15%
restriction on investments in securities that are not readily marketable.
During the term of a swap, cap, floor or collar, changes in the value
of the instrument are recognized as unrealized gains or losses by marking to
market to reflect the market value of the instrument. When the instrument is
terminated, the Fund will record a realized gain or loss equal to the
difference, if any, between the proceeds from (or cost of) the closing
transaction and a Fund's basis in the contract.
The federal income tax treatment with respect to swap transactions,
caps, floors, and collars may impose limitations on the extent to which a Fund
may engage in such transactions.
RISK MANAGEMENT
17
The Fund may employ non-hedging risk management techniques. Examples of
such strategies include synthetically altering the duration of its portfolio or
the mix of securities in its portfolio. For example, if the Advisor wishes to
extend maturities in a fixed income portfolio in order to take advantage of an
anticipated decline in interest rates, but does not wish to purchase the
underlying long term securities, it might cause the Fund to purchase futures
contracts on long term debt securities. Such non-hedging risk management
techniques are not speculative, but because they involve leverage include, as do
all leveraged transactions, the possibility of losses as well as gains that are
greater than if these techniques involved the purchase and sale of the
securities themselves rather than their synthetic derivatives.
PORTFOLIO TURNOVER
The Portfolio's turnover rates for the fiscal year ended August 31,
1998, for eleven months ended July 31, 1999 and for the fiscal year ended July
31, 2000: 16%, 29% (not annualized) and 84%, respectively. A rate of 100%
indicates that the equivalent of all of the Portfolio's assets have been sold
and reinvested in a year. High portfolio turnover may result in the realization
of substantial net capital gains or losses. To the extent net short term capital
gains are realized, any distributions resulting from such gains are considered
ordinary income for federal income tax purposes. See "Taxes" below.
INVESTMENT RESTRICTIONS
The investment restrictions of the Fund and Portfolio are identical,
unless otherwise specified. Accordingly, references below to the Fund also
include the Portfolio unless the context requires otherwise; similarly,
references to the Portfolio also include the Fund unless the context requires
otherwise.
The investment restrictions below have been adopted by the Fund and
Portfolio. Except where otherwise noted, these investment restrictions are
"fundamental" policies which, under the 1940 Act, may not be changed without the
vote of a majority of the outstanding voting securities of the Fund or
Portfolio, as the case may be. A "majority of the outstanding voting securities"
is defined in the 1940 Act as the lesser of (a) 67% or more of the voting
securities present 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. The percentage limitations
contained in the restrictions below apply at the time of the purchase of
securities. Whenever the Fund is requested to vote on a change in the
fundamental investment restrictions of the Portfolio, the Trust will hold a
meeting of Fund shareholders and will cast its votes as instructed by the Fund's
shareholders.
The Fund and its corresponding Portfolio:
1. May not make any investment inconsistent with the Fund's classification
as a diversified investment company under the Investment Company Act of
1940.
2. May not purchase any security which would cause the Fund to concentrate
its investments in the securities of issuers primarily engaged in any
particular industry except as permitted by the SEC;
3. May not issue senior securities, except as permitted under the
Investment Company Act of 1940 or any rule, order or interpretation
thereunder;
4. May not borrow money, except to the extent permitted by applicable law;
5. May not underwrite securities of other issuers, except to the extent
that the Fund, in disposing of portfolio securities, may be deemed an
underwriter within the meaning of the 1933 Act;
18
6. May not purchase or sell real estate, except that, to the extent
permitted by applicable law, the Fund may (a) invest in securities or
other instruments directly or indirectly secured by real estate, (b)
invest in securities or other instruments issued by issuers that invest
in real estate and (c) make direct investments in mortgages;
7. May not purchase or sell commodities or commodity contracts unless
acquired as a result of ownership of securities or other instruments
issued by persons that purchase or sell commodities or commodities
contracts; but this shall not prevent the Fund from purchasing, selling
and entering into financial futures contracts (including futures
contracts on indices of securities, interest rates and currencies),
options on financial futures contracts (including futures contracts on
indices of securities, interest rates and currencies), warrants, swaps,
forward contracts, foreign currency spot and forward contracts or other
derivative instruments that are not related to physical commodities;
and
8. May make loans to other persons, in accordance with the Fund's
investment objective and policies and to the extent permitted by
applicable law.
NON-FUNDAMENTAL INVESTMENT RESTRICTIONS. The investment restrictions
described below are not fundamental policies of the Fund and its corresponding
Portfolio and may be changed by their Trustees. These non-fundamental investment
policies require that the Fund and its corresponding Portfolio:
(i) May not acquire any illiquid securities, such as repurchase agreements
with more than seven days to maturity or fixed time deposits with a
duration of over seven calendar days, if as a result thereof, more than
15% of the market value of the Fund's net assets would be in investments
which are illiquid;
(ii) May not purchase securities on margin, make short sales of securities, or
maintain a short position, provided that this restriction shall not be
deemed to be applicable to the purchase or sale of when-issued or delayed
delivery securities, or to short sales that are covered in accordance
with SEC rules; and
(iii) May not acquire securities of other investment companies, except as
permitted by the 1940 Act or any order pursuant thereto.
There will be no violation of any investment restriction if that
restriction is complied with at the time the relevant action is taken
notwithstanding a later change in market value of an investment, in net or total
assets, in the securities rating of the investment, or any other later change.
For purposes of the fundamental investment restriction regarding
industry concentration, JPMIM may classify issuers by industry in accordance
with classifications set forth in the DIRECTORY OF COMPANIES FILING ANNUAL
REPORTS WITH THE SECURITIES AND EXCHANGE COMMISSION or other sources. In the
absence of such classification or if JPMIM determines in good faith based on its
own information that the economic characteristics affecting a particular issuer
make it more appropriately considered to be engaged in a different industry,
JPMIM may classify an issuer accordingly. For instance, personal credit finance
companies and business credit finance companies are deemed to be separate
industries and wholly owned finance companies are considered to be in the
industry of their parents if their activities are primarily related to financing
the activities of their parents.
TRUSTEES AND MEMBERS OF THE ADVISORY BOARD
TRUSTEES
The Trustees of the Trust, who are also the Trustees of the Portfolio
and the other Master Portfolios as defined below, their principal occupations
during the past five years and dates of birth are set forth below. The mail
address of the Trustees is c/o Pierpont Group, Inc., 461 Fifth Avenue, New
York, New York 10017.
19
FREDERICK S. ADDY--Trustee; Retired; Prior to April 1994, Executive
Vice President and Chief Financial Officer Amoco Corporation. His date of birth
is January 1, 1932.
WILLIAM G. BURNS--Trustee; Retired, Former Vice Chairman and Chief
Financial Officer, NYNEX. His date of birth is November 2, 1932.
ARTHUR C. ESCHENLAUER--Trustee; Retired; Former Senior Vice President,
Morgan Guaranty Trust Company of New York. His date of birth is May 23, 1934.
MATTHEW HEALEY(1)--Trustee, Chairman and Chief Executive Officer;
Chairman, Pierpont Group, Inc., since prior to 1995. His date of birth is August
23, 1937.
MICHAEL P. MALLARDI--Trustee; Retired; Prior to April 1996, Senior Vice
President, Capital Cities/ABC, Inc. and President, Broadcast Group. His date of
birth is March 17, 1934.
The Trustees of the Trust are the same as the Trustees of the
Portfolio. A majority of the disinterested Trustees have adopted written
procedures reasonably appropriate to deal with potential conflicts of interest
arising from the fact that the same individuals are Trustees of the Trust, the
Portfolio and the J.P. Morgan Institutional Funds, up to and including creating
a separate board of trustees.
Each Trustee is currently paid an annual fee of $75,000 for serving as
Trustee of the Trust, each of the Master Portfolios (as defined below), J.P.
Morgan Institutional Funds and J.P. Morgan Series Trust and is reimbursed for
expenses incurred in connection with service as a Trustee. The Trustees may hold
various other directorships unrelated to the Fund.
- - -----------------------
(1) Mr. Healey is an "interested person" (as defined in the 1940 Act) of
the Trust.
20
Trustee compensation expenses paid by the Trust for the calendar year
ended December 31, 1999 are set forth below.
AGGREGATE TRUSTEE TOTAL TRUSTEE COMPENSATION ACCRUED BY THE
COMPENSATION MASTER PORTFOLIOS(*), J.P. MORGAN
NAME OF TRUSTEE PAID BY THE INSTITUTIONAL FUNDS, J.P. MORGAN SERIES
- - --------------- TRUST DURING 1999 TRUST AND THE TRUST DURING 1999 (**)
----------------- ---------------------------------------
Frederick S. Addy, Trustee $12,720 $75,000
William G. Burns, Trustee $12,720 $75,000
Arthur C. Eschenlauer, Trustee $12,720 $75,000
Matthew Healey, Trustee(***), $12,720 $75,000
Chairman and Chief Executive Officer
Michael P. Mallardi, Trustee $12,720 $75,000
(*) Includes the Portfolio and 18 other Portfolios (collectively the "Master
Portfolios") for which JPMIM acts as investment adviser.
(**) No investment company within the fund complex has a pension or retirement
plan. Currently there are 22 investment companies (comprised of 19 investment
companies comprising the Master Portfolios, the Trust, the J.P. Morgan
Institutional Funds and J.P. Morgan Series Trust) in the fund complex.
(***) During 1999, Pierpont Group, Inc. paid Mr. Healey, in his role as Chairman
of Pierpont Group, Inc., compensation in the amount of $153,800, contributed
$23,100 to a defined contribution plan on his behalf and paid $17,300 in
insurance premiums for his benefit.
The Trustees decide upon matters of general policy and are responsible
for overseeing the Trust's and the Portfolio's business affairs. The Portfolio
and the Trust have entered into a Fund Services Agreement with Pierpont Group,
Inc. to assist the Trustees in exercising their overall supervisory
responsibilities over the affairs of the Portfolio and the Trust. Pierpont
Group, Inc. was organized in July 1989 to provide services for the J.P. Morgan
Family of Funds, (formerly "The Pierpont Family of Funds"), and the Trustees are
the equal and sole shareholders of Pierpont Group, Inc. The Trust and the
Portfolio have agreed to pay Pierpont Group, Inc. a fee in an amount
representing its reasonable costs in performing these services. These costs are
periodically reviewed by the Trustees. The principal offices of Pierpont Group,
Inc. are located at 461 Fifth Avenue, New York, NY 10017.
The aggregate fees paid to Pierpont Group, Inc. by the Fund and the
Portfolio during the indicated fiscal years are set forth below:
FUND -- For the fiscal year ended August 31, 1998, for the eleven months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $13,354, $9,770 and
$6,210, respectively.
21
PORTFOLIO -- For the fiscal year ended August 31, 1998, for the eleven months
ended July 31, 1999 and for the fiscal year ended July 31, 2000: $21,294,
$17,915 and $12,760, respectively.
MEMBERS OF THE ADVISORY BOARD
The Trustees determined as of January 26, 2000 to establish an advisory
board and appoint four members ("Members of the Advisory Board") thereto. Each
member serves at the pleasure of the Trustees. The advisory board is distinct
from the Trustees and provides advice to the Trustees as to investment,
management and operations of the Trust; but has no power to vote upon any matter
put to a vote of the Trustees. The advisory board and the members thereof also
serve each of the J.P. Morgan Funds, J.P. Morgan Series Trust, and collectively,
together with the Trust (the "Trusts") and the Master Portfolios. It is also the
current intention of the Trustees that the Members of the Advisory Board will be
proposed at the next shareholders' meeting, expected to be held within a year
from the date hereof, for election as Trustees of each of the Trusts and the
Master Portfolios. The creation of the Advisory Board and the appointment of the
members thereof was designed so that the Board of Trustees will continuously
consist of persons able to assume the duties of Trustees and be fully familiar
with the business and affairs of each of the Trusts and the Master Portfolios,
in anticipation of the current Trustees reaching the mandatory retirement age of
seventy. Each member of the Advisory Board is paid an annual fee of $75,000 for
serving in this capacity for the Trust, each of the Master Portfolios, the J.P.
Morgan Funds and the J.P. Morgan Series Trust and is reimbursed for expenses
incurred in connection for such service. The members of the Advisory Board may
hold various other directorships unrelated to these funds. The mailing address
of the Members of the Advisory Board is c/o Pierpont Group, Inc., 461 Fifth
Avenue, New York, New York 10017. Their names, principal occupations during the
past five years and dates of birth are set forth below:
Ann Maynard Gray - Former President, Diversified Publishing Group and
Vice President, Capital Cities/ABC, Inc. Her date of birth is August 22, 1945.
John R. Laird -- Retired; Former Chief Executive Officer, Shearson
Lehman Brothers and The Boston Company. His date of birth is June 21, 1942.
Gerard P. Lynch -- Retired; Former Managing Director, Morgan Stanley
Group and President and Chief Operating Officer, Morgan Stanley Services, Inc.
His date of birth is October 5, 1936.
James J. Schonbachler -- Retired; Prior to September, 1998, Managing
Director, Bankers Trust Company and Chief Executive Officer and Director,
Bankers Trust A.G., Zurich and BT Brokerage Corp. His date of birth is January
26, 1943.
OFFICERS
The Trust's and Portfolio's executive officers (listed below), other
than the Chief Executive Officer and the officers who are employees of the
Advisor, are provided and compensated by Funds Distributor, Inc. ("FDI"), a
wholly owned indirect subsidiary of Boston Institutional Group, Inc. The
officers conduct and supervise the business operations of the Trust and the
Portfolio. The Trust and the Portfolio have no employees.
The officers of the Trust and the Portfolio, their principal
occupations during the past five years and dates of birth are set forth below.
Unless otherwise specified, each officer holds the same position with the Trust
and the Portfolio. The business address of each of the officers unless otherwise
noted is Funds Distributor, Inc., 60 State Street, Suite 1300, Boston,
Massachusetts 02109.
22
MATTHEW HEALEY; Chief Executive Officer; Chairman, Pierpont Group,
since prior to 1995. His address is c/o Pierpont Group, Inc., 461 Fifth Avenue,
New York, New York 10017. His date of birth is August 23, 1937.
MARGARET W. CHAMBERS; Vice President and Secretary. Senior Vice
President and General Counsel of FDI since April, 1998. From August 1996 to
March 1998, Ms. Chambers was Vice President and Assistant General Counsel for
Loomis, Sayles & Company, L.P. From January 1986 to July 1996, she was an
associate with the law firm of Ropes & Gray. Her date of birth is October 12,
1959.
MARIE E. CONNOLLY; Vice President and Assistant Treasurer. President,
Chief Executive Officer, Chief Compliance Officer and Director of FDI, Premier
Mutual Fund Services, Inc., an affiliate of FDI ("Premier Mutual") and an
officer of certain investment companies advised or administered by FDI since
prior to 1995. Her date of birth is August 1, 1957.
DOUGLAS C. CONROY; Vice President and Assistant Treasurer. Assistant
Vice President and Assistant Department Manager of Treasury Services and
Administration of FDI and an officer of certain investment companies distributed
or administered by FDI. Prior to April 1997, Mr. Conroy was Supervisor of
Treasury Services and Administration of FDI. His date of birth is March 31,
1969.
KAREN JACOPPO-WOOD; Vice President and Assistant Secretary. Vice
President and Senior Counsel of FDI and an officer of certain investment
companies distributed or administered by FDI. From June 1994 to January 1996,
Ms. Jacoppo-Wood was a Manager of SEC Registration at Scudder, Stevens & Clark,
Inc. Her date of birth is December 29, 1966.
CHRISTOPHER J. KELLEY; Vice President and Assistant Secretary. Vice
President and Senior Associate General Counsel of FDI and Premier Mutual and an
officer of certain investment companies distributed or administered by FDI. From
April 1994 to July 1996, Mr. Kelley was Assistant Counsel at Forum Financial
Group. His date of birth is December 24, 1964.
KATHLEEN K. MORRISEY; Vice President and Assistant Secretary. Vice
President and Assistant Secretary of FDI. Manager of Treasury Services
Administration and an officer of certain investment companies advised or
administered by Montgomery Asset Management, L.P. and Dresdner RCM Global
Investors, Inc., and their respective affiliates. From July 1994 to November
1995, Ms. Morrisey was a Fund Accountant II for Investors Bank & Trust Company.
Her date of birth is July 5, 1972.
MARY A. NELSON; Vice President and Assistant Treasurer. Vice President
and Manager of Treasury Services and Administration of FDI and Premier Mutual
and an officer of certain investment companies distributed or administered by
FDI. Her date of birth is April 22, 1964.
MARY JO PACE; Assistant Treasurer. Vice President, Morgan Guaranty
Trust Company of New York since 1990. Ms. Pace serves in the Funds
Administration group as a Manager for the Budgeting and Expense Processing
Group. Prior to September 1995, Ms. Pace served as a Fund Administrator for
Morgan Guaranty Trust Company of New York. Her address is 60 Wall Street, New
York, New York 10260. Her date of birth is March 13, 1966.
GEORGE A. RIO; President and Treasurer. Executive Vice President and
Client Service Director of FDI since April 1998. From June 1995 to March 1998,
Mr. Rio was Senior Vice President and Senior Key Account Manager for Putnam
Mutual Funds. His date of birth is January 2, 1955.
23
CHRISTINE ROTUNDO; Assistant Treasurer. Vice President, Morgan Guaranty
Trust Company of New York. Ms. Rotundo serves as Manager of the Funds
Infrastructure group and is responsible for the management of special projects.
Prior to January 2000, she served as Manager of the Tax Group in the Funds
Administration group and was responsible for U.S. mutual fund tax matters. Her
address is 60 Wall Street, New York, New York 10260. Her date of birth is
September 26, 1965.
ELBA VASQUEZ; Vice President and Assistant Secretary. Vice President of
FDI since February 1999. Ms. Vasquez served as a Sales Associate for FDI from
May 1996. Prior to that she served in various mutual fund sales and marketing
positions for U.S. Trust Company of New York. Her date of birth is December 14,
1961.
As of October 31, 2000, Trustees, Members of the Advisory Board and
Officers as a group owned less than 1% of the outstanding shares of the Fund.
CODES OF ETHICS
The Trust, FDI and the Advisor have adopted codes of ethics pursuant to
Rule 17j-1 under the 1940 Act. Each of these codes permits personnel subject to
such code to invest in securities, including securities that may be purchased or
held by the funds. Such purchases, however, are subject to procedures reasonably
necessary to prevent access persons from engaging in any unlawful conduct set
forth in Rule 17j-1.
INVESTMENT ADVISOR
The Fund has not retained the services of an investment adviser because
it seeks to achieve its investment objective by investing all of its investable
assets in the Portfolio. Subject to the supervision of the Portfolio's Trustees,
the Advisor makes the Portfolio's day-to-day investment decisions, arranges for
the execution of Portfolio transactions and generally manages the Portfolio's
investments. Prior to October 28, 1998, Morgan was the Investment Advisor.
JPMIM, a wholly owned subsidiary of J.P. Morgan & Co. Incorporated
("J.P. Morgan"), is a registered investment adviser under the Investment
Advisers Act of 1940, as amended, and manages employee benefit funds of
corporations, labor unions and state and local governments and the accounts
of other institutional investors, including investment companies. Certain of
the assets of employee benefit accounts under its management are invested in
commingled pension trust funds for which Morgan serves as trustee.
J.P. Morgan, through the Advisor and other subsidiaries, acts as
investment advisor to individuals, governments, corporations, employee benefit
plans, mutual funds and other institutional investors with combined assets under
management of approximately $373 billion.
Morgan, whose principal offices are at 60 Wall Street, New York, New
York 10260, is a New York trust company which conducts a general banking and
trust business. Morgan is subject to regulation by the New York State Banking
Department and is a member bank of the Federal Reserve System. Through offices
in New York City and abroad, Morgan offers a wide range of services, primarily
to governmental, institutional, corporate and high net worth individual
customers in the United States and throughout the world. The firm, through its
predecessor firms, has been in business for over a century and has been managing
investments since 1913. Morgan is also a wholly owned subsidiary of J.P. Morgan,
a bank holding company organized under the laws of the State of Delaware.
The basis of the Advisor's investment process is fundamental investment
research as the firm believes that fundamentals should determine an asset's
value over the long term. Morgan currently employs approximately 415 research
analysts, capital market researchers, portfolio managers and traders and has one
of the largest research staffs in the money management industry. The Advisor has
investment management divisions located in New York, London, Tokyo, Frankfurt
and Singapore to cover companies, industries and countries on site. The
Advisor's fixed
24
income investment process is based on analysis of real rates, sector
diversification, and quantitative and credit analysis.
The investment advisory services the Advisor provides to the Portfolio
are not exclusive under the terms of the Advisory Agreement. The Advisor is free
to and does render similar investment advisory services to others. The Advisor
serves as investment advisor to personal investors and other investment
companies and acts as fiduciary for trusts, estates and employee benefit plans.
Certain of the assets of trusts and estates under management are invested in
common trust funds for which the Advisor serves as trustee. The accounts which
are managed or advised by the Advisor have varying investment objectives and the
Advisor invests assets of such accounts in investments substantially similar to,
or the same as, those which are expected to constitute the principal investments
of the Portfolio. Such accounts are supervised by officers and employees of the
Advisor who may also be acting in similar capacities for the Portfolio. See
"Portfolio Transactions."
Sector weightings are generally similar to a benchmark with the
emphasis on security selection as the method to achieve investment performance
superior to the benchmark. The benchmark for the fund is the Lehman Brothers
Intermediate Competitive Bond Index (1-17), an unmanaged index that measures
municipal bond market performance. Previously the fund had used the Lehman
Brothers 1-16 Year Municipal Bond Index as a comparative broad-based securities
market index. The fund has chosen to use the Lehman Brothers Intermediate
Competitive Bond Index (1-17) because it is more widely disseminated.
The Portfolio is managed by employees of the Advisor who, in acting for
their customers, including the Portfolio, do not discuss their investment
decisions with any personnel of J.P. Morgan with the exception of certain
investment management affiliates of J.P. Morgan or broker affiliates of J.P.
Morgan which execute transactions on behalf of the Fund.
As compensation for the services rendered and related expenses such as
salaries of advisory personnel borne by the Advisor under the Investment
Advisory Agreement, the Portfolio has agreed to pay the Advisor a fee, which is
computed daily and may be paid monthly, equal to the annual rate of 0.30% of the
Portfolio's average daily net assets.
For the fiscal year ended August 31, 1998, for the eleven months ended
July 31, 1999 and for the fiscal year ended July 31, 2000, the advisory fees
paid by the Portfolio were $2,017,415, $2,295,351 and $2,344,217, respectively.
The Investment Advisory Agreement provides that it will continue in
effect for a period of two years after execution only if specifically approved
thereafter annually in the same manner as the Distribution Agreement. See
"Distributor" below. The Investment Advisory Agreement will terminate
automatically if assigned and is terminable at any time without penalty by a
vote of a majority of the Portfolio's Trustees, or by a vote of the holders of a
majority of the Portfolio's outstanding voting securities, on 60 days' written
notice to the Advisor and by the Advisor on 90 days' written notice to the
Portfolio. See "Additional Information."
Under separate agreements, Morgan provides certain financial, fund
accounting and administrative services to the Trust and the Portfolio and
shareholder services for the Trust. See "Services Agent" and "Shareholder
Servicing" below.
DISTRIBUTOR
FDI serves as the Trust's exclusive Distributor and holds itself
available to receive purchase orders for the Fund's shares. In that capacity,
FDI has been granted the right, as agent of the Trust, to solicit and accept
orders for the purchase of the Fund's shares in accordance with the terms of the
Distribution Agreement between the Trust and
25
FDI. Under the terms of the Distribution Agreement between FDI and the Trust,
FDI receives no compensation in its capacity as the Trust's distributor.
The Distribution Agreement shall continue in effect with respect to the
Fund for a period of two years after execution only if it is approved at least
annually thereafter (i) by a vote of the holders of a majority of the Fund's
outstanding shares or by its Trustees and (ii) by a vote of a majority of the
Trustees of the Trust who are not "interested persons" (as defined by the 1940
Act) of the parties to the Distribution Agreement, cast in person at a meeting
called for the purpose of voting on such approval (see "Trustees and Members of
the Advisory Board" and "Officers"). The Distribution Agreement will terminate
automatically if assigned by either party thereto and is terminable at any time
without penalty by a vote of a majority of the Trustees of the Trust, a vote of
a majority of the Trustees who are not "interested persons" of the Trust, or by
a vote of the holders of a majority of the Fund's outstanding shares as defined
under "Additional Information," in any case without payment of any penalty on 60
days' written notice to the other party. The principal offices of FDI are
located at 60 State Street, Suite 1300, Boston, Massachusetts 02109.
CO-ADMINISTRATOR
Under Co-Administration Agreements with the Trust and the Portfolio
dated August 1, 1996, FDI also serves as the Trust's and the Portfolio's
Co-Administrator. The Co-Administration Agreements may be renewed or amended by
the respective Trustees without a shareholder vote. The Co-Administration
Agreements are terminable at any time without penalty by a vote of a majority of
the Trustees of the Trust or the Portfolio, as applicable, on not more than 60
days' written notice nor less than 30 days' written notice to the other party.
The Co-Administrator may subcontract for the performance of its obligations,
provided, however, that unless the Trust or the Portfolio, as applicable,
expressly agrees in writing, the Co-Administrator shall be fully responsible for
the acts and omissions of any subcontractor as it would for its own acts or
omissions. See "Services Agent" below.
FDI (i) provides office space, equipment and clerical personnel for
maintaining the organization and books and records of the Trust and the
Portfolio; (ii) provides officers for the Trust and the Portfolio; (iii)
prepares and files documents required for notification of state securities
administrators; (iv) reviews and files marketing and sales literature; (v) files
Portfolio regulatory documents and mails Portfolio communications to Trustees
and investors; and (vi) maintains related books and records.
For its services under the Co-Administration Agreements, the Fund and
Portfolio have agreed to pay FDI fees equal to its allocable share of an annual
complex-wide charge of $425,000 plus FDI's out-of-pocket expenses. The amount
allocable to the Fund or Portfolio is based on the ratio of its net assets to
the aggregate net assets of the Trust, the Master Portfolios and certain other
investment companies subject to similar agreements with FDI.
The table below sets forth for the Fund and the Portfolio the
administrative fees paid to FDI for the fiscal periods indicated.
FUND -- For the fiscal year ended August 31, 1998, for the eleven months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $9,860, $6,691 and
$4,660, respectively.
PORTFOLIO -- For the fiscal years ended August 31, 1998, for the eleven months
ended July 31, 1999 and for the fiscal year ended July 31, 2000: $9,832, $7,665
and $5,677, respectively.
SERVICES AGENT
The Trust, on behalf of the Fund, and the Fund's corresponding
Portfolio have entered into Administrative Services Agreements (the "Services
Agreements") with Morgan, pursuant to which Morgan is responsible for
26
certain administrative and related services provided to the Fund and Portfolio,
respectively. The Services Agreements may be terminated at any time, without
penalty, by the Trustees or Morgan, in each case on not more than 60 days' nor
less than 30 days' written notice to the other party.
Under the Services Agreements, Morgan provides certain administrative
and related services to the Fund and the Portfolio, including services related
to tax compliance, preparation of financial statements, calculation of
performance data, oversight of service providers and certain regulatory and
Board of Trustee matters.
Under the Services Agreements, the Fund and the Portfolio have agreed
to pay Morgan fees equal to its allocable share of an annual complex-wide
charge. This charge is calculated daily based on the aggregate net assets of the
Master Portfolios and J.P. Morgan Series Trust in accordance with the following
annual schedule: 0.09% of the first $7 billion of their aggregate average daily
net assets and 0.04% of their aggregate average daily net assets in excess of $7
billion, less the complex-wide fees payable to FDI. The portion of this charge
payable by the Fund and Portfolio is determined by the proportionate share that
its net assets bear to the total net assets of the Trust, the Master Portfolios,
the other investors in the Master Portfolios for which Morgan provides similar
services and J.P. Morgan Series Trust.
The table below sets forth for the Fund and the Portfolio the fees paid
to Morgan as Services Agent.
FUND -- For the fiscal year ended August 31, 1998, for the eleven months ended
July 31, 1999 and for the fiscal year ended July 31, 2000: $122,927, $110,004
and $93,624, respectively.
PORTFOLIO -- For the fiscal year ended August 31, 1998 for the eleven months
ended July 31, 1999 and for the fiscal year ended July 31, 2000: $198,156,
$203,283 and $194,913, respectively.
CUSTODIAN AND TRANSFER AGENT
The Bank of New York ("BONY"), One Wall Street, New York, New York
10286, serves as the Trust's custodian and fund accounting agent. Pursuant to
the Custodian Contract and Fund Accounting Agreement with the Trust, BONY is
responsible for holding portfolio securities and cash and maintaining the books
of account and records of the Fund's portfolio transactions.
State Street Bank and Trust Company ("State Street"), 225 Franklin
Street, Boston, Massachusetts 02110, serves as the Trust's transfer and dividend
disbursing agent. As transfer agent and dividend disbursing agent, State Street
is responsible for maintaining account records detailing the ownership of Fund
shares and for crediting income, capital gains and other changes in share
ownership to shareholder accounts.
SHAREHOLDER SERVICING
The Trust, on behalf of the Fund, has entered into a Shareholder
Servicing Agreement with Morgan pursuant to which Morgan acts as shareholder
servicing agent for its customers and for other Fund investors who are customers
of a financial professional. Under this agreement, Morgan is responsible for
performing shareholder account, administrative and servicing functions, which
include but are not limited to, answering inquiries regarding account status and
history, the manner in which purchases and redemptions of Fund shares may be
effected, and certain other matters pertaining to the Fund; assisting customers
in designating and changing dividend options, account designations and
addresses; providing necessary personnel and facilities to coordinate the
establishment and maintenance of shareholder accounts and records with the
Fund's transfer agent; transmitting purchase and redemption orders to the Fund's
transfer agent and arranging for the wiring or other transfer of funds to and
from customer accounts in connection with orders to purchase or redeem Fund
shares; verifying purchase and redemption
27
orders, transfers among and changes in accounts; informing the Distributor of
the gross amount of purchase orders for Fund shares; monitoring the activities
of the Fund's transfer agent; and providing other related services.
Effective August 1, 1998, under the Shareholder Servicing Agreement,
the Fund has agreed to pay Morgan for these services a fee at an annual rate of
0.25% (expressed as a percentage of the average daily net asset value of Fund
shares owned by or for shareholders).
The shareholder servicing fees paid by the Fund to Morgan for the
fiscal year ended August 31, 1998, for the eleven months ended July 31, 1999 and
for the fiscal year ended July 31, 2000: $851,806, $1,034,199 and $945,553,
respectively.
If Morgan were prohibited from providing any of the services under the
Shareholder Servicing Agreement and the Services Agreements, the Trustees would
seek an alternative provider of such services. In such event, changes in the
operation of the Fund or the Portfolio might occur and a shareholder might no
longer be able to avail himself or herself of any services then being provided
to shareholders by Morgan.
The Fund may be sold to or through financial intermediaries who are
customers of J.P. Morgan ("financial professionals"), including financial
institutions and broker-dealers, that may be paid fees by J.P. Morgan or its
affiliates for services provided to their clients that invest in the Fund. See
"Financial Professionals" below. Organizations that provide record keeping or
other services to certain employee benefit or retirement plans that include the
Fund as an investment alternative may also be paid a fee.
FINANCIAL PROFESSIONALS
The services provided by financial professionals may include
establishing and maintaining shareholder accounts, processing purchase and
redemption transactions, arranging for bank wires, performing shareholder
subacounting, answering client inquiries regarding the Trust, assisting clients
in changing dividend options, account designations and addresses, providing
periodic statements showing the client's account balance and integrating these
statements with those of other transactions and balances in the client's other
accounts serviced by the financial professional, transmitting proxy statements,
periodic reports, updated prospectuses and other communications to shareholders
and, with respect to meetings of shareholders, collecting, tabulating and
forwarding executed proxies and obtaining such other information and performing
such other services as J.P. Morgan or the financial professional's clients may
reasonably request and agree upon with the financial professional.
Although there is no sales charge levied directly by the Fund,
financial professionals may establish their own terms and conditions for
providing their services and may charge investors a transaction-based or other
fee for their services. Such charges may vary among financial professionals but
in all cases will be retained by the financial professional and will not be
remitted to the Fund or J.P. Morgan.
The Fund has authorized one or more brokers to accept purchase and
redemption orders on its behalf. Such brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
The Fund will be deemed to have received a purchase or redemption order when an
authorized broker or, if applicable, a broker's authorized designee, accepts the
order. These orders will be priced at the Fund's net asset value next calculated
after they are so accepted.
INDEPENDENT ACCOUNTANTS
The independent accountants of the Trust and the Portfolio are
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036. PricewaterhouseCoopers LLP conducts an annual audit of the financial
statements of the Fund and the Portfolio, assists in the preparation and/or
review of the Fund's and the
28
Portfolio's federal and state income tax returns and consults with the Fund and
the Portfolio as to matters of accounting and federal and state income taxation.
EXPENSES
In addition to the fees payable to Pierpont Group, Inc., JPMIM, Morgan
and FDI under various agreements discussed under "Trustees and Members of the
Advisory Board," "Officers," "Investment Advisor", "Co-Administrator",
"Distributor", "Services Agent" and "Shareholder Servicing" above, the Fund and
the Portfolio are responsible for usual and customary expenses associated with
their respective operations. Such expenses include organization expenses, legal
fees, accounting and audit expenses, insurance costs, the compensation and
expenses of the Trustees, costs associated with registration under federal
securities laws, and extraordinary expenses applicable to the Fund or the
Portfolio. For the Fund, such expenses also include transfer, registrar and
dividend disbursing costs, the expenses of printing and mailing reports, notices
and proxy statements to Fund shareholders; and filing fees under state
securities laws. For the Portfolio, such expenses also include custodian fees
and brokerage expenses.
PURCHASE OF SHARES
ADDITIONAL MINIMUM BALANCE INFORMATION. If your account balance falls
below the minimum for 30 days as a result of selling shares (and not because of
performance), the Fund reserves the right to request that you buy more shares or
close your account. If your account balance is still below the minimum 60 days
after notification, the Fund reserves the right to close out your account and
send the proceeds to the address of record.
METHOD OF PURCHASE. Investors may open Fund accounts and purchase
shares as described in the Prospectus. References in the Prospectus and this
Statement of Additional Information to customers of Morgan or a Financial
Professional include customers of their affiliates and references to
transactions by customers with Morgan or a Financial Professional include
transactions with their affiliates. Only Fund investors who are using the
services of a financial institution acting as shareholder servicing agent
pursuant to an agreement with the Trust on behalf of the Fund may make
transactions in shares of the Fund. All purchase orders must be accepted by the
Distributor.
The Fund may, at its own option, accept securities in payment for
shares. The securities delivered in such a transaction are valued by the method
described in "Net Asset Value" as of the day the Fund receives the securities.
This is a taxable transaction to the shareholder. Securities may be accepted in
payment for shares only if they are, in the judgment of the Advisor, appropriate
investments for the Fund's corresponding Portfolio. In addition, securities
accepted in payment for shares must: (i) meet the investment objective and
policies of Portfolio; (ii) be acquired by the Fund for investment and not for
resale (other than for resale to the Portfolio); (iii) be liquid securities
which are not restricted as to transfer either by law or liquidity of market;
and (iv) if stock, have a value which is readily ascertainable as evidenced by a
listing on a stock exchange, OTC market or by readily available market
quotations from a dealer in such securities. The Fund reserves the right to
accept or reject at its own option any and all securities offered in payment for
its shares.
Prospective investors may purchase shares with the assistance of a
Financial Professional, and a Financial Professional may charge the investor a
fee for this service and other services it provides to its customers.
REDEMPTION OF SHARES
Investors may redeem shares as described in the Prospectus.
If the Trust, on behalf of the Fund, and the Portfolio determines that
it would be detrimental to the best interest of the remaining shareholders of a
Fund to make payment wholly or partly in cash, payment of the
29
redemption price may be made in whole or in part by a distribution in kind of
securities from the Fund, in lieu of cash, in conformity with the applicable
rule of the SEC. If shares are redeemed in kind, the redeeming shareholder might
incur transaction costs in converting the assets into cash. The method of
valuing portfolio securities is described under "Net Asset Value," and such
valuation will be made as of the same time the redemption price is determined.
The Trust on behalf of the Fund and the Portfolio have elected to be governed by
Rule 18f-1 under the 1940 Act pursuant to which the Fund and the Portfolio are
obligated to redeem shares solely in cash up to the lesser of $250,000 or one
percent of the net asset value of the Fund during any 90 day period for any one
shareholder. The Trust will redeem Fund shares in kind only if it has received a
redemption in kind from the Portfolio and therefore shareholders of the Fund
that receive redemptions in kind will receive securities of the Portfolio. The
Portfolio has advised the Trust that the Portfolio will not redeem in kind
except in circumstances in which the Fund is permitted to redeem in kind.
FURTHER REDEMPTION INFORMATION. Investors should be aware that
redemptions from the Fund may not be processed if a redemption request is not
submitted in proper form. To be in proper form, the Fund must have received the
shareholder's taxpayer identification number and address. In addition, if a
shareholder sends a check for the purchase of fund shares and shares are
purchased before the check has cleared, the transmittal of redemption proceeds
from the shares will occur upon clearance of the check which may take up to 15
days. The Trust, on behalf of the Fund, and the Portfolio reserves the right to
suspend the right of redemption and to postpone the date of payment upon
redemption as follows: (i) for up to seven days, (ii) during periods when the
New York Stock Exchange is closed for other than weekends and holidays or when
trading on such Exchange is restricted as determined by the SEC by rule or
regulation, (iii) during periods in which an emergency, as determined by the
SEC, exists that causes disposal by the Portfolio of, or evaluation of the net
asset value of, its portfolio securities to be unreasonable or impracticable, or
(iv) for such other periods as the SEC may permit. For information regarding
redemption orders placed through a financial professional, please see "Financial
Professionals" above.
EXCHANGE OF SHARES
An investor may exchange shares of the Fund for shares of any J.P.
Morgan Fund, J.P. Morgan Institutional Fund or J.P. Morgan Series Trust Fund
without charge. An exchange may be made so long as after the exchange the
investor has shares, in each fund in which he or she remains an investor, with a
value of at least that fund's minimum investment amount. Shareholders should
read the prospectus of the fund into which they are exchanging and may only
exchange between fund accounts that are registered in the same name, address and
taxpayer identification number. Shares are exchanged on the basis of relative
net asset value per share. Exchanges are in effect redemptions from one fund and
purchases of another fund and the usual purchase and redemption procedures and
requirements are applicable to exchanges. The Fund generally intends to pay
redemption proceeds in cash, however, since it reserves the right at its sole
discretion to pay redemptions over $250,000 in-kind as a portfolio of
representative stocks rather than in cash, the Fund reserves the right to deny
an exchange request in excess of that amount. See "Redemption of Shares".
Shareholders subject to federal income tax who exchange shares in one fund for
shares in another fund may recognize capital gain or loss for federal income tax
purposes. Shares of the fund to be acquired are purchased for settlement when
the proceeds from redemption become available. In the case of investors in
certain states, state securities laws may restrict the availability of the
exchange privilege. The Fund reserves the right to discontinue, alter or limit
its exchange privilege at any time.
DIVIDENDS AND DISTRIBUTIONS
The Fund declares and pays dividends and distributions as described
under "Dividends and Distributions" in the Prospectus.
Dividends and capital gains distributions paid by a Fund are
automatically reinvested in additional shares of the Fund unless the shareholder
has elected to have them paid in cash. Dividends and distributions to be paid in
30
cash are credited to the shareholder's account at Morgan or at his financial
professional or, in the case of certain Morgan customers, are mailed by check in
accordance with the customer's instructions. The Fund reserves the right to
discontinue, alter or limit the automatic reinvestment privilege at any time.
If a shareholder has elected to receive dividends and/or capital gain
distributions in cash and the postal or other delivery service is unable to
deliver checks to the shareholder's address of record, such shareholder's
distribution option will automatically be converted to having all dividend and
other distributions reinvested in additional shares. No interest will accrue on
amounts represented by uncashed distribution or redemption checks.
NET ASSET VALUE
The Fund computes its net asset value separately for each class of
shares outstanding once daily as of the close of trading on the New York Stock
Exchange (normally 4:00 p.m. eastern time) on each business day as described in
the prospectus. The net asset value will not be computed on the day the
following legal holidays are observed: New Year's Day, Martin Luther King, Jr.
Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day, and Christmas Day. On days when U.S. trading markets close
early in observance of these holidays, the Fund will close for purchases and
redemptions at the same time. The Fund and the Portfolio may also close for
purchases and redemptions at such other times as may be determined by the Board
of Trustees to the extent permitted by applicable law. The days on which net
asset value is determined are the Fund's business days.
The net asset value of the Fund is equal to the value of the Fund's
investment in its corresponding Portfolio (which is equal to the Fund's pro rata
share of the total investment of the Fund and of any other investors in the
Portfolio less the Fund's pro rata share of the Portfolio's liabilities) less
the Fund's liabilities. The following is a discussion of the procedures used by
the Portfolio corresponding to the Fund in valuing its assets.
Listed options on debt securities traded on U.S. option exchanges shall
be valued at their closing price on such exchanges. Futures on debt securities
and related options traded on commodities exchanges shall be valued at their
closing price as of the close of such commodities exchanges, which is currently
4:15p.m., New York time. Options and future traded on foreign exchanges shall be
valued at the last sale or close price available prior to the calculation of the
Funds' net asset value. Non-listed OTC options and swaps shall be valued at the
closing price provided by a counterparty or third-party broker.
Fixed income securities with a maturity of 60 days or more, are
generally valued using bid quotations readily available from and supplied
daily by pricing services or brokers. If such prices are generally not
readily available from the Fund's pricing services or brokers, such
securities are priced in accordance with fair value procedures adopted by the
Trustees. Such fair value procedures include the use of pricing services,
which use prices based upon yields or prices of securities of comparable
quality, coupon, maturity and type; indications as to values from dealers;
and general market conditions. Fixed income securities with a remaining
maturity of less than 60 days are valued by the amortized cost method.
PERFORMANCE DATA
From time to time, the Fund may quote performance in terms of yield,
tax equivalent yield, actual distributions, total returns or capital
appreciation in reports, sales literature and advertisements published by the
Trust. Current performance information for the Fund may be obtained by calling
the number provided on the cover page of this Statement of Additional
Information. See also the Prospectus.
Comparative performance information may be used from time to time in
advertising the Fund's shares, including appropriate market indices including
the benchmarks indicated under "Investment Advisor" above or data
31
from Lipper Analytical Services, Inc., Micropal, Inc., Ibbotson Associates,
Morningstar Inc., the Dow Jones Industrial Average and other industry
publications.
YIELD QUOTATIONS. As required by regulations of the SEC, the annualized
yield for the Fund is computed by dividing the Fund's net investment income per
share earned during a 30-day period by the net asset value on the last day of
the period. The average daily number of shares outstanding during the period
that are eligible to receive dividends is used in determining the net investment
income per share. Income is computed by totaling the interest earned on all debt
obligations during the period and subtracting from that amount the total of all
recurring expenses incurred during the period. The 30-day yield is then
annualized on a bond-equivalent basis assuming semi-annual reinvestment and
compounding of net investment income.
The historical yield information for the Fund at July 31, 2000: 30-day
yield: 4.39%; 30-day tax equivalent yield at 39.6% tax rate: 7.28%.
TOTAL RETURN QUOTATIONS. The Fund may advertise "total return" and
non-standardized total return data. The total return shows what an investment in
a Fund would have earned over a specified period of time (one, five or ten years
or since commencement of operations, if less) assuming that all distributions
and dividends by the Fund were reinvested on the reinvestment dates during the
period and less all recurring fees. This method of calculating total return is
required by regulations of the SEC. Total return data similarly calculated,
unless otherwise indicated, over other specified periods of time may also be
used. All performance figures are based on historical earnings and are not
intended to indicate future performance.
As required by regulations of the SEC, the average annual total return
of the Fund for a period is computed by assuming a hypothetical initial payment
of $1,000. It is then assumed that all of the dividends and distributions by the
Fund over the period are reinvested. It is then assumed that at the end of the
period, the entire amount is redeemed. The average annual total return is then
calculated by determining the annual rate required for the initial payment to
grow to the amount which would have been received upon redemption.
Aggregate total returns, reflecting the cumulative percentage change
over a measuring period, may also be calculated.
Below is set forth historical return information for the Fund at July
31, 2000: Average annual total return, 1 year: 3.74%; average annual total
return, 5 years: 4.69%; average annual total return, 10 years: 5.99%; aggregate
total return, 1 year: 3.74%; aggregate total return, 5 years: 25.77%; aggregate
total return, 10 years: 78.94%.
GENERAL. The Fund's performance will vary from time to time depending
upon market conditions, the composition of the Portfolio, and its operating
expenses. Consequently, any given performance quotation should not be considered
representative of the Fund's performance for any specified period in the future.
In addition, because performance will fluctuate, it may not provide a basis for
comparing an investment in the Fund with certain bank deposits or other
investments that pay a fixed yield or return for a stated period of time.
From time to time, the Fund may, in addition to any other permissible
information, include the following types of information in advertisements,
supplemental sales literature and reports to shareholders: (1) discussions of
general economic or financial principles (such as the effects of compounding and
the benefits of dollar-cost averaging); (2) discussions of general economic
trends; (3) presentations of statistical data to supplement such discussions;
(4) descriptions of past or anticipated portfolio holdings for the Fund; (5)
descriptions of investment strategies for the Fund; (6) descriptions or
comparisons of various savings and investment products (including, but not
limited to, qualified retirement plans and individual stocks and bonds), which
may or may not include the Fund; (7) comparisons of investment products
(including the Fund) with relevant markets or industry indices or other
appropriate benchmarks; (8) discussions of fund rankings or ratings by
recognized rating organizations; and (9)
32
discussions of various statistical methods quantifying the Fund's volatility
relative to its benchmark or to past performance, including risk adjusted
measures. The Fund may also include calculations, such as hypothetical
compounding examples, which describe hypothetical investment results in such
communications. Such performance examples will be based on an express set of
assumptions and are not indicative of the performance of the Fund.
PORTFOLIO TRANSACTIONS
The Advisor places orders for the Portfolio for all purchases and sales
of portfolio securities, enters into repurchase agreements, and may enter into
reverse repurchase agreements and execute loans of portfolio securities on
behalf of the Portfolio. See "Investment Objectives and Policies."
Fixed income and debt securities and municipal bonds and notes are
generally traded at a net price with dealers acting as principal for their own
accounts without a stated commission. The price of the security usually includes
profit to the dealers. In underwritten offerings, securities are purchased at a
fixed price which includes an amount of compensation to the underwriter,
generally referred to as the underwriter's concession or discount. On occasion,
certain securities may be purchased directly from an issuer, in which case no
commissions or discounts are paid
Portfolio transactions for the Portfolio will be undertaken principally
to accomplish a Portfolio's objective in relation to expected movements in the
general level of interest rates. The Portfolio may engage in short-term trading
consistent with its objective. See "Investment Objective and Policies --
Portfolio Turnover."
In connection with portfolio transactions for the Portfolio, the
Advisor intends to seek the best execution on a competitive basis for both
purchases and sales of securities.
Subject to the overriding objective of obtaining the best execution of
orders, the Advisor may allocate a portion of the Portfolio's brokerage
transactions to affiliates of the Advisor. In order for affiliates of the
Advisor to effect any portfolio transactions for the Portfolio, the commissions,
fees or other remuneration received by such affiliates must be reasonable and
fair compared to the commissions, fees, or other remuneration paid to other
brokers in connection with comparable transactions involving similar securities
being purchased or sold on a securities exchange during a comparable period of
time. Furthermore, the Trustees of the Portfolio, including a majority of the
Trustees who are not "interested persons," have adopted procedures which are
reasonably designed to provide that any commissions, fees, or other remuneration
paid to such affiliates are consistent with the foregoing standard.
Portfolio securities will not be purchased from or through or sold to
or through the Co-Administrator, the Distributor or the Advisor or any other
"affiliated person" (as defined in the 1940 Act) of the Co-Administrator,
Distributor or Advisor when such entities are acting as principals, except to
the extent permitted by law. In addition, the Portfolio will not purchase
securities during the existence of any underwriting group relating thereto of
which the Advisor or an affiliate of the Advisor is a member, except to the
extent permitted by law.
Investment decisions made by the Advisor are the product of many
factors in addition to basic suitability for the particular portfolio or other
client in question. Thus, a particular security may be bought or sold for
certain clients even though it could have been bought or sold for other clients
at the same time. Likewise, a particular security may be bought for one or more
clients when one or more other clients are selling the same security. The Fund
may only sell a security to other portfolios or accounts managed by the Advisor
or its affiliates in accordance with procedures adopted by the Trustees.
33
On those occasions when the Advisor deems the purchase or sale of a
security to be in the best interests of the Portfolio as well as other customers
including other Portfolios, the Advisor to the extent permitted by applicable
laws and regulations, may, but is not obligated to, aggregate the securities to
be sold or purchased for the Portfolio with those to be sold or purchased for
other customers in order to obtain best execution, including lower brokerage
commissions if appropriate. In such event, allocation of the securities so
purchased or sold as well as any expenses incurred in the transaction will be
made by the Advisor in the manner it considers to be most equitable and
consistent with its fiduciary obligations to the Portfolio. In some instances,
this procedure might adversely affect the Portfolio.
If the Portfolio writes options that effect a closing purchase
transaction with respect to an option written by it, normally such transaction
will be executed by the same broker-dealer who executed the sale of the option.
The writing of options by the Portfolio will be subject to limitations
established by each of the exchanges governing the maximum number of options in
each class which may be written by a single investor or group of investors
acting in concert, regardless of whether the options are written on the same or
different exchanges or are held or written in one or more accounts or through
one or more brokers. The number of options which the Portfolio may write may be
affected by options written by the Advisor for other investment advisory
clients. An exchange may order the liquidation of positions found to be in
excess of these limits, and it may impose certain other sanctions.
MASSACHUSETTS TRUST
The Trust is a "Massachusetts business trust" of which the Fund is a
separate and distinct series. A copy of the Declaration of Trust for the Trust
is on file in the office of the Secretary of The Commonwealth of Massachusetts.
Under Massachusetts law, shareholders of such a trust may, under certain
circumstances, be held personally liable as partners for the obligations of the
trust. However, the Trust's Declaration of Trust provides that the shareholders
will not be subject to any personal liability for the acts or obligations of any
Fund and that every written agreement, obligation, instrument or undertaking
made on behalf of any Fund will contain a provision to the effect that the
shareholders are not personally liable thereunder.
Effective October 10, 1996, the name of the Trust was changed from "The
Pierpont Funds" to "The JPM Pierpont Funds," and the Fund's name changed
accordingly. Effective January 1, 1998, the name of the Trust was changed from
"The JPM Pierpont Funds" to "J.P. Morgan Funds", and the Fund's name changed
accordingly.
The Trust's Declaration of Trust further provides that the name of the
Trust refers to the Trustees collectively as Trustees, not as individuals or
personally, that no Trustee, officer, employee or agent of the Fund is liable to
the Fund or to a shareholder, and that no Trustee, officer, employee, or agent
is liable to any third persons in connection with the affairs of the Fund,
except as such liability may arise from his or its own bad faith, willful
misfeasance, gross negligence or reckless disregard of his or its duties to such
third persons. It also provides that all third persons shall look solely to Fund
property for satisfaction of claims arising in connection with the affairs of
the Fund. With the exceptions stated, the Trust's Declaration of Trust provides
that a Trustee, officer, employee, or agent is entitled to be indemnified
against all liability in connection with the affairs of the Fund.
The Trust shall continue without limitation of time subject to the
provisions in the Declaration of Trust concerning termination by action of the
shareholders or by action of the Trustees upon notice to the shareholders.
DESCRIPTION OF SHARES
The Trust is an open-end management investment company organized as a
Massachusetts business trust in which the Fund represents a separate series of
shares of beneficial interest. See "Massachusetts Trust."
34
The Declaration of Trust permits the Trustees to issue an unlimited
number of full and fractional shares ($0.001 par value) of one or more series
and classes within any series and to divide or combine the shares (of any
series, if applicable) without changing the proportionate beneficial interest of
each shareholder in a Fund (or in the assets of other series, if applicable).
Each share represents an equal proportional interest in a Fund with each other
share. Upon liquidation of the Fund, holders are entitled to share pro rata in
the net assets of the Fund available for distribution to such shareholders. See
"Massachusetts Trust." Shares of a Fund have no preemptive or conversion rights
and are fully paid and nonassessable. The rights of redemption and exchange are
described in the Prospectus and elsewhere in this Statement of Additional
Information.
The shareholders of the Trust are entitled to one vote for each dollar
of net asset value (or a proportionate fractional vote in respect of a
fractional dollar amount), on matters on which shares of the Fund shall be
entitled to vote. Subject to the 1940 Act, the Trustees themselves have the
power to alter the number and the terms of office of the Trustees, to lengthen
their own terms, or to make their terms of unlimited duration subject to certain
removal procedures, and appoint their own successors, PROVIDED, HOWEVER, that
immediately after such appointment the requisite majority of the Trustees have
been elected by the shareholders of the Trust. The voting rights of shareholders
are not cumulative so that holders of more than 50% of the shares voting can, if
they choose, elect all Trustees being selected while the shareholders of the
remaining shares would be unable to elect any Trustees. It is the intention of
the Trust not to hold meetings of shareholders annually. The Trustees may call
meetings of shareholders for action by shareholder vote as may be required by
either the 1940 Act or the Trust's Declaration of Trust.
Shareholders of the Trust have the right, upon the declaration in
writing or vote of more than two-thirds of its outstanding shares, to remove a
Trustee. The Trustees will call a meeting of shareholders to vote on removal of
a Trustee upon the written request of the record holders of 10% of the Trust's
shares. In addition, whenever ten or more shareholders of record who have been
such for at least six months preceding the date of application, and who hold in
the aggregate either shares having a net asset value of at least $25,000 or at
least 1% of the Trust's outstanding shares, whichever is less, shall apply to
the Trustees in writing, stating that they wish to communicate with other
shareholders with a view to obtaining signatures to request a meeting for the
purpose of voting upon the question of removal of any Trustee or Trustees and
accompanied by a form of communication and request which they wish to transmit,
the Trustees shall within five business days after receipt of such application
either: (1) afford to such applicants access to a list of the names and
addresses of all shareholders as recorded on the books of the Trust; or (2)
inform such applicants as to the approximate number of shareholders of record,
and the approximate cost of mailing to them the proposed communication and form
of request. If the Trustees elect to follow the latter course, the Trustees,
upon the written request of such applicants, accompanied by a tender of the
material to be mailed and of the reasonable expenses of mailing, shall, with
reasonable promptness, mail such material to all shareholders of record at their
addresses as recorded on the books, unless within five business days after such
tender the Trustees shall mail to such applicants and file with the SEC,
together with a copy of the material to be mailed, a written statement signed by
at least a majority of the Trustees to the effect that in their opinion either
such material contains untrue statements of fact or omits to state facts
necessary to make the statements contained therein not misleading, or would be
in violation of applicable law, and specifying the basis of such opinion. After
opportunity for hearing upon the objections specified in the written statements
filed, the SEC may, and if demanded by the Trustees or by such applicants shall,
enter an order either sustaining one or more of such objections or refusing to
sustain any of them. If the SEC shall enter an order refusing to sustain any of
such objections, or if, after the entry of an order sustaining one or more of
such objections, the SEC shall find, after notice and opportunity for hearing,
that all objections so sustained have been met, and shall enter an order so
declaring, the Trustees shall mail copies of such material to all shareholders
with reasonable promptness after the entry of such order and the renewal of such
tender.
The trustees have authorized the issuance and sale to the public of
shares of 18 series of the Trust. The Trustees have no current intention to
create any classes within the initial series or any subsequent series. The
35
Trustees may, however, authorize the issuance of shares of additional series and
the creation of classes of shares within any series with such preferences,
privileges, limitations and voting and dividend rights as the Trustees may
determine. The proceeds from the issuance of any additional series would be
invested in separate, independently managed portfolios with distinct investment
objectives, policies and restrictions, and share purchase, redemption and net
asset valuation procedures. Any additional classes would be used to distinguish
among the rights of different categories of shareholders, as might be required
by future regulations or other unforeseen circumstances. All consideration
received by the Trust for shares of any additional series or class, and all
assets in which such consideration is invested, would belong to that series or
class, subject only to the rights of creditors of the Trust and would be subject
to the liabilities related thereto. Shareholders of any additional series or
class will approve the adoption of any management contract or distribution plan
relating to such series or class and of any changes in the investment policies
related thereto, to the extent required by the 1940 Act.
As of October 31, 2000, there are none who owned of record or, to the
knowledge of management, who are beneficial owners of more than 5% of the
outstanding shares of the Fund.
For information relating to mandatory redemption of Fund shares or
their redemption at the option of the trust under certain circumstances, see the
Prospectus.
SPECIAL INFORMATION CONCERNING INVESTMENT STRUCTURE
Unlike other mutual funds which directly acquire and manage their own
portfolio of securities, the Fund is an open-end management investment company
which seeks to achieve its investment objective by investing all of its
investable assets in the Master Portfolio, a separate registered investment
company with the same investment objective and policies as the Fund. Fund
shareholders are entitled to one vote for each dollar of net asset value (or a
proportionate fractional vote in respect of a fractional dollar amount), on
matter on which shares of the Fund shall be entitled to vote.
In addition to selling a beneficial interest to the Fund, the Portfolio
may sell beneficial interests to other mutual funds or institutional investors.
Such investors will invest in the Portfolio on the same terms and conditions and
will bear a proportionate share of the Portfolio's expenses. However, the other
investors investing in the Portfolio may sell shares of their own fund using a
different pricing structure than the Fund. Such different pricing structures may
result in differences in returns experienced by investors in other funds that
invest in the Portfolio. Such differences in returns are not uncommon and are
present in other mutual fund structures. Information concerning other holders of
interests in the Portfolio is available from Morgan at (800) 521-5411.
The Trust may withdraw the investment of the Fund from the Portfolio at
any time if the Board of Trustees of the Trust determines that it is in the best
interests of the Fund to do so. Upon any such withdrawal, the Board of Trustees
would consider what action might be taken, including the investment of all the
assets of the Fund in another pooled investment entity having the same
investment objective and restrictions as the Fund or the retaining of an
investment adviser to manage the Fund's assets in accordance with the investment
policies with respect to the Portfolio described above and in the Fund's
prospectus described below.
Certain changes in the Portfolio's fundamental investment policies or
restrictions, or a failure by the Fund's shareholders to approve such change in
the Portfolio's investment restrictions, may require withdrawal of the Fund's
interest in the Portfolio. Any such withdrawal could result in a distribution in
kind of portfolio securities (as opposed to a cash distribution) from the
Portfolio which may or may not be readily marketable. The distribution in kind
may result in the Fund having a less diversified portfolio of investments or
adversely affect the Fund's liquidity, and the Fund could incur brokerage, tax
or other charges in converting the securities to cash. Notwithstanding the
above, there are other means for meeting shareholder redemption requests, such
as borrowing.
36
Smaller funds investing in the Portfolio may be materially affected by
the actions of larger funds investing in the Portfolio. For example, if a large
fund withdraws from the Portfolio, the remaining funds may subsequently
experience higher pro rata operating expenses, thereby producing lower returns.
Additionally, because the Portfolio would become smaller, it may become
less diversified, resulting in potentially increased portfolio risk (however,
these possibilities also exist for traditionally structured funds which have
large or institutional investors who may withdraw from a fund). Also funds with
a greater pro rata ownership in the Portfolio could have effective voting
control of the operations of the Portfolio. Whenever the Fund is requested to
vote on matters pertaining to the Portfolio (other than a vote by the Fund to
continue the operation of the Portfolio upon the withdrawal of another investor
in the Portfolio), the Trust will hold a meeting of shareholders of the Fund and
will cast all of its votes proportionately as instructed by the Fund's
shareholders. The Trust will vote the shares held by Fund shareholders who do
not give voting instructions in the same proportion as the shares of Fund
shareholders who do give voting instructions. Shareholders of the Fund who do
not vote will have no affect on the outcome of such matters.
TAXES
The following discussion of tax consequences is based on U.S. federal
tax laws in effect on the date of this Statement of Additional Information.
These laws and regulations are subject to change by legislative or
administrative action, possibly on a retroactive basis.
The Fund intends to continue to qualify and remain qualified as a
regulated investment company under Subchapter M of the Code. As a regulated
investment company, a Fund must, among other things, (a) derive at least 90% of
its gross income from dividends, interest, payments with respect to loans of
stock and securities, gains from the sale or other disposition of stock,
securities or foreign currency and other income (including but not limited to
gains from options, futures, and forward contracts) derived with respect to its
business of investing in such stock, securities or foreign currency; and (b)
diversify its holdings so that, at the end of each fiscal quarter of its taxable
year, (i) at least 50% of the value of the Fund's total assets is represented by
cash, cash items, U.S. Government securities, investments in other regulated
investment companies, and other securities limited, in respect of any one
issuer, to an amount not greater than 5% of the Fund's total assets, and 10% of
the outstanding voting securities of such issuer, and (ii) not more than 25% of
the value of its total assets is invested in the securities of any one issuer
(other than U.S. Government securities or securities of other regulated
investment companies).
As a regulated investment company, the Fund (as opposed to its
shareholders) will not be subject to federal income taxes on the net investment
income and capital gains that it distributes to its shareholders, provided that
at least 90% of its net investment income and realized net short-term capital
gains in excess of net long-term capital losses for the taxable year is
distributed in accordance with the Code's timing requirements.
Under the Code, the Fund will be subject to a 4% excise tax on a
portion of its undistributed taxable income and capital gains if it fails to
meet certain distribution requirements by the end of the calendar year. The Fund
intends to make distributions in a timely manner and accordingly does not expect
to be subject to the excise tax.
For federal income tax purposes, dividends that are declared by a Fund
in October, November or December as of a record date in such month and actually
paid in January of the following year will be treated as if they were paid on
December 31 of the year declared. Therefore, such dividends generally will be
taxable to a shareholder in the year declared rather than the year paid.
The Fund intends to qualify to pay exempt-interest dividends to its
shareholders by having, at the close of each quarter of its taxable year, at
least 50% of the value of its total assets consist of tax exempt securities. An
37
exempt-interest dividend is that part of dividend distributions made by the Fund
which is properly designated as consisting of interest received by the Fund on
tax exempt securities. Shareholders will not incur any federal income tax on the
amount of exempt-interest dividends received by them from the Fund, other than
the alternative minimum tax under certain circumstances. In view of the Fund's
investment policies, it is expected that a substantial portion of all dividends
will be exempt-interest dividends, although the Fund may from time to time
realize and distribute net short-term capital gains and may invest limited
amounts in taxable securities under certain circumstances.
Distributions of net investment income (other than exempt-interest
dividends) and realized net short-term capital gains in excess of net long-term
capital losses are generally taxable to shareholders of the Fund as ordinary
income whether such distributions are taken in cash or reinvested in additional
shares. The Fund generally pays a monthly dividend. If dividend payments exceed
income earned by the Fund, the over-distribution would be considered a return of
capital rather than a dividend payment. The Fund intends to pay dividends in
such a manner so as to minimize the possibility of a return of capital.
Distributions of net long-term capital gains (i.e., net long-term capital gains
in excess of net short-term capital losses) are taxable to shareholders of the
Fund as long-term capital gains, regardless of whether such distributions are
taken in cash or reinvested in additional shares and regardless of how long a
shareholder has held shares in the Fund. In general, long-term capital gain of
an individual shareholder will be subject to a 20% rate of tax.
Gains or losses on sales of portfolio securities will be treated as
long-term capital gains or losses if the securities have been held for more than
one year except in certain cases where, if applicable, a put option is acquired
or a call option is written thereon. Other gains or losses on the sale of
securities will be short-term capital gains or losses. Gains and losses on the
sale, lapse or other termination of options on securities will be treated as
gains and losses from the sale of securities. If an option written by the
Portfolio lapses or is terminated through a closing transaction, such as a
repurchase by the Portfolio of the option from its holder, the Portfolio will
realize a short-term capital gain or loss, depending on whether the premium
income is greater or less than the amount paid by the Portfolio in the closing
transaction. If securities are purchased by the Portfolio pursuant to the
exercise of a put option written by it, the Portfolio will subtract the premium
received from its cost basis in the securities purchased.
Any distribution of net investment income or capital gains will have
the effect of reducing the net asset value of Fund shares held by a shareholder
by the same amount as the distribution. If the net asset value of the shares is
reduced below a shareholder's cost as a result of such a distribution, the
distribution, although constituting a return of capital to the shareholder, will
be taxable as described above. Investors should consider the consequences of
purchases shares in Fund shortly before the Fund declares a sizable dividend
distribution.
Any gain or loss realized on the redemption or exchange of Fund
shares by a shareholder who is not a dealer in securities will be treated as
long-term capital gain or loss if the shares have been held for more than one
year, and otherwise as short-term capital gain or loss. Long-term capital
gain of an individual holder generally is subject to a maximum tax rate of 20%.
However, if Fund shares are acquired after December 31, 2000 and held for
more than five years, the maximum long-term capital gain tax rate will be
reduced to 18%. Any loss realized by a shareholder upon the redemption or
exchange of shares in the Fund held for six months or less (i) will be
treated as a long-term capital loss to the extent of any long-term capital
gain distributions received by the shareholder with respect to such shares,
and (ii) will be disallowed to the extent of any exempt-interest dividends
received by the shareholder with respect to such shares. In addition, no loss
will be allowed on the redemption or exchange of shares of the Fund, if
within a period beginning 30 days before the date of such redemption or
exchange and ending 30 days after such date, the shareholder acquires (such
as through dividend reinvestment) securities that are substantially identical
to shares of the Fund. Investors are urged to consult their tax advisors
concerning the limitations on the deductibility of capital losses.
Options and futures contracts entered into by the Portfolio may create
"straddles" for U.S. federal income tax purposes and this may affect the
character and timing of gains or losses realized by the Portfolio on options and
futures contracts or on the underlying securities.
38
Certain options and futures held by the Fund at the end of each fiscal
year will be required to be "marked to market" for federal income tax purposes
- - -- i.e., treated as having been sold at market value. For options and futures
contracts, 60% of any gain or loss recognized on these deemed sales and on
actual dispositions will be treated as long-term capital gain or loss, and the
remainder will be treated as short-term capital gain or loss regardless of how
long the Fund has held such options or futures.
If a correct and certified taxpayer identification number is not on
file, the Fund is required, subject to certain exemptions, to withhold 31% of
certain payments made or distributions declared to non-corporate shareholders.
For federal income tax purposes, the fund incurred approximately
$1,137,035 of capital losses in the period from November 1, 1999 to July 31,
2000. These losses were deferred for tax purposes until August 1, 2000.
STATE AND LOCAL TAXES. The Fund may be subject to state or local taxes
in jurisdictions in which the Fund is deemed to be doing business. In addition,
the treatment of a Fund and its shareholders in those states which have income
tax laws might differ from treatment under the federal income tax laws.
Shareholders should consult their own tax advisors with respect to any state or
local taxes.
OTHER TAXATION. The Trust is organized as a Massachusetts business
trust and, under current law, neither the Trust nor the Fund is liable for any
income or franchise tax in The Commonwealth of Massachusetts, provided that the
Fund continues to qualify as a regulated investment company under Subchapter M
of the Code. The Portfolio is organized as a New York trust. The Portfolio is
not subject to any federal income taxation or income or franchise tax in the
State of New York or The Commonwealth of Massachusetts. The investment by the
Fund in the Portfolio does not cause the Fund to be liable for any income or
franchise tax in the State of New York.
ADDITIONAL INFORMATION
Telephone calls to the Fund, J.P. Morgan or a Financial Professional as
shareholder servicing agent may be tape recorded. With respect to the securities
offered hereby, this Statement of Additional Information and the Prospectus do
not contain all the information included in the Trust's registration statement
filed with the SEC under the 1933 Act and the 1940 Act and the Portfolio's
registration statements filed under the 1940 Act. Pursuant to the rules and
regulations of the SEC, certain portions have been omitted. The registration
statements including the exhibits filed therewith may be examined at the office
of the SEC in Washington, D.C.
Statements contained in this Statement of Additional Information and
the Prospectus concerning the contents of any contract or other document are not
necessarily complete, and in each instance, reference is made to the copy of
such contract or other document filed as an exhibit to the applicable
Registration Statements. Each such statement is qualified in all respects by
such reference.
No dealer, salesman or any other person has been authorized to give any
information or to make any representations, other than those contained in the
Prospectus and this Statement of Additional Information, in connection with the
offer contained therein and, if given or made, such other information or
representations must not be relied upon as having been authorized by any of the
Trust, the Fund or the Distributor. The Prospectus and this Statement of
Additional Information do not constitute an offer by the Fund or by the
Distributor to sell or solicit any offer to buy any of the securities offered
hereby in any jurisdiction to any person to whom it is unlawful for the Fund or
the Distributor to make such offer in such jurisdictions.
FINANCIAL STATEMENTS
The following financial statements and the report thereon of
PricewaterhouseCoopers LLP are incorporated herein by reference to the Fund's
July 31, 2000 annual report filing made with the SEC on September 29, 2000
(Accession Number 0000894089-00-000008) made pursuant to Section 30(b) of the
1940 Act and Rule 30b2-1
39
thereunder. The financial reports are available without charge upon request by
calling J.P. Morgan Funds Services at (800) 521-5411. The Fund's financial
statements include the financial statements of the Portfolio.
40
APPENDIX A
DESCRIPTION OF SECURITY RATINGS
STANDARD & POOR'S
CORPORATE AND MUNICIPAL BONDS
AAA - Debt rated AAA have the highest ratings assigned by Standard & Poor's
to a debt obligation. Capacity to pay interest and repay principal is
extremely strong.
AA - Debt rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issues only in a small
degree.
A - Debt rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher
rated categories.
BBB - Debt rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt in
higher rated categories.
BB - Debt rated BB are regarded as having less near-term vulnerability to
default than other speculative issues. However, they face major ongoing
uncertainties or exposure to adverse business, financial or economic
conditions which could lead to inadequate capacity to meet timely
interest and principal payments.
B - An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or
economic conditions will likely impair the obligor's capacity or
willingness to meet its financial commitment on the obligation.
CCC - An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial, and economic conditions
for the obligor to meet its financial commitment on the obligation. In
the event of adverse business, financial, or economic conditions, the
obligor is not likely to have the capacity to meet its financial
commitment on the obligation.
CC - An obligation rated CC is currently highly vulnerable to nonpayment.
C - The C rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments
on this obligation are being continued.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
A - Issues assigned this highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are further
refined with the designations 1, 2, and 3 to indicate the relative
degree of safety.
A-1 - This designation indicates that the degree of safety regarding timely
payment is very strong.
A-2 - This designation indicates that the degree of safety regarding timely
payment is satisfactory.
A-1
A-3 - This designation indicates that the degree of safety regarding timely
payment is adequate.
SHORT-TERM TAX-EXEMPT NOTES
SP-1 - The short-term tax-exempt note rating of SP-1 is the highest rating
assigned by Standard & Poor's and has a very strong or strong capacity
to pay principal and interest. Those issues determined to possess
overwhelming safety characteristics are given a "plus" (+) designation.
SP-2 - The short-term tax-exempt note rating of SP-2 has a satisfactory
capacity to pay principal and interest.
MOODY'S
CORPORATE AND MUNICIPAL BONDS
Aaa - Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred
to as "gilt edge." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong
position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally
known as high grade bonds. They are rated lower than the best bonds
because margins of protection may not be as large as in Aaa securities
or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks
appear somewhat larger than in Aaa securities.
A - Bonds which are rated A possess many favorable investment attributes
and are to be considered as upper medium grade obligations. Factors
giving security to principal and interest are considered adequate but
elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest
payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding
investment characteristics and in fact have speculative characteristics
as well.
Ba - Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not
well safeguarded during both good and bad times over the future.
Uncertainty of position characterizes bonds in this class.
B - Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time
may be small.
Caa - Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
A-2
C - Bonds which are rated C are the lowest rated class of bonds and issues
so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
COMMERCIAL PAPER, INCLUDING TAX EXEMPT
Prime-1 - Issuers rated Prime-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory
obligations. Prime-1 repayment capacity will normally be
evidenced by the following characteristics:
- Leading market positions in well established industries.
- High rates of return on funds employed.
- Conservative capitalization structures with moderate reliance
on debt and ample asset protection.
- Broad margins in earnings coverage of fixed financial charges and
high internal cash generation.
- Well established access to a range of financial markets and
assured sources of alternate liquidity.
Prime-2 Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations. This
will normally be evidenced by many of the characteristics cited
above but to a lesser degree. Earnings trends and coverage
ratios, while sound, may be more subject to variation.
Capitalization characteristics, while still appropriate, may be
more affected by external conditions. Ample alternate liquidity
is maintained.
Prime-3 Issuers rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term obligations. The
effect of industry characteristics and market compositions may be
more pronounced. Variability in earnings and profitability may
result in changes in the level of debt protection measurements
and may require relatively high financial leverage. Adequate
alternate liquidity is maintained.
SHORT-TERM TAX EXEMPT NOTES
MIG-1 - The short-term tax-exempt note rating MIG-1 is the highest rating
assigned by Moody's for notes judged to be the best quality.
Notes with this rating enjoy strong protection from established
cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both.
MIG-2 - MIG-2 rated notes are of high quality but with margins of protection
not as large as MIG-1.
A-3