MAS FUNDS
STATEMENT OF ADDITIONAL INFORMATION
January 31, 1998
MAS Funds (the "Fund") is a no load mutual fund consisting of twenty-seven
portfolios offering a variety of investment alternatives. This Statement of
Additional Information sets forth information about the Fund applicable to all
twenty-seven portfolios.
This Statement is not a prospectus but should be read in conjunction with the
Fund's prospectuses dated January 31, 1998, each as revised from time to time.
To obtain any of these prospectuses, please call the Client Services Group.
Client Services Group: 1-800-354-8185
Prices and Investment Results: 1-800-522-1525
TABLE OF CONTENTS
Page
----
Business History 3
Strategies and Investments 3
Repurchase Agreements 3
Securities Lending 3
Foreign Investments 4
Futures Contracts 5
Restrictions on the Use of Futures Contracts 6
Risk Factors in Futures Transactions 6
Options 7
Options on Foreign Currencies 8
Combined Transactions 9
Risks of Options on Futures Contracts, Forward Contracts and Options on
Foreign Currencies 9
Swap Contracts 10
Foreign Currency Exchange-Related Securities 11
Municipal Bonds 12
Duration 13
Mortgage-Backed Securities 14
Stripped Mortgage-Backed Securities 16
U.S. Government Securities 16
Zero Coupon Bonds 17
Eurodollar and Yankee Obligations 17
Brady Bonds 18
Cash Reserves Portfolio 18
Tax Considerations 19
Purchase of Shares 22
Redemption of Shares 22
Transactions with Broker/Dealers 22
Shareholder Services 23
Investment Limitations 23
Management of the Fund 26
Distribution Plans 30
Shareholder Service Agreement 31
Investment Adviser 31
Administration 33
Distributor for Fund 34
Custodians 34
Portfolio Transactions 34
Annual Turnover 36
General Information 36
Performance Information 38
Comparative Indices 44
Financial Statements 50
Appendix-Description of Securities and Ratings 50
2
BUSINESS HISTORY
MAS Funds (formerly MAS Pooled Trust Fund) is an open end management investment
company established under Pennsylvania law as a Pennsylvania business trust
under an Amended and Restated Agreement and Declaration of Trust dated November
18, 1993. The Fund was originally established as The MAS Pooled Trust Fund, a
Pennsylvania business trust, in February, 1984.
STRATEGIES AND INVESTMENTS
The following information supplements the characteristics and risks of
strategies and investments set forth in the Fund's prospectuses:
REPURCHASE AGREEMENTS
Each of the Fund's portfolios may invest in repurchase agreements collateralized
by U.S. Government securities, certificates of deposit and certain bankers'
acceptances. Repurchase agreements are transactions by which a portfolio
purchases a security and simultaneously commits to resell that security to the
seller (a bank or securities dealer) at an agreed upon price on an agreed upon
date (usually within seven days of purchase). The resale price reflects the
purchase price plus an agreed upon market rate of interest which is unrelated to
the coupon rate or date of maturity of the purchased security. In these
transactions, the securities purchased by a portfolio have a total value in
excess of the value of the repurchase agreement and are held by the portfolio's
custodian bank until repurchased. Such agreements permit a portfolio to keep all
its assets at work while retaining "overnight" flexibility in pursuit of
investments of a longer-term nature. The Adviser and the Fund's Administrator
will continually monitor the value of the underlying securities to ensure that
their value always equals or exceeds the repurchase price.
The use of repurchase agreements involves certain risks. For example, if the
seller of the agreements defaults on its obligation to repurchase the underlying
securities at a time when the value of these securities has declined, a
portfolio may incur a loss upon disposition of them. If the seller of the
agreement becomes insolvent and subject to liquidation or reorganization under
the Bankruptcy Code or other laws, a bankruptcy court may determine that the
underlying securities are collateral not within the control of a portfolio and
therefore subject to sale by the trustee in bankruptcy. Finally, it is possible
that a portfolio may not be able to substantiate its interest in the underlying
securities. While the Fund's management acknowledges these risks, it is expected
that they can be controlled through stringent security selection criteria and
careful monitoring procedures.
SECURITIES LENDING
Each portfolio may lend its investment securities to qualified institutional
investors who need to borrow securities in order to complete certain
transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage operations. By lending its investment
securities, a portfolio attempts to increase its income through the receipt of
interest on the loan. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the account of
the portfolio. Each portfolio may lend its investment securities to qualified
brokers, dealers, domestic and foreign banks or other financial institutions, so
long as the terms, the structure and the aggregate amount of such loans are not
inconsistent with the Investment Company Act of 1940 ( the "1940 Act") or the
rules and regulations or interpretations of the Securities and Exchange
Commission (the "SEC") thereunder, which currently require that (a) the borrower
pledge and maintain with the portfolio collateral consisting of cash, an
irrevocable letter of credit issued by a domestic U.S. bank, or securities
issued or guaranteed by the U.S. Government having a value at all times not less
than 100% of the value of the securities loaned, (b) the borrower add to such
3
collateral whenever the price of the securities loaned rises (i.e., the borrower
"marks to the market" on a daily basis), (c) the loan be made subject to
termination by the portfolio at any time, and (d) the portfolio receive
reasonable interest on the loan (which may include the portfolio investing any
cash collateral in interest bearing short-term investments), any distribution on
the loaned securities and any increase in their market value. All relevant facts
and circumstances, including the creditworthiness of the broker, dealer or
institution, will be considered in making decisions with respect to the lending
of securities, subject to review by the Trustees.
At the present time, the staff of the SEC does not object if an investment
company pays reasonable negotiated fees in connection with loaned securities, so
long as such fees are set forth in a written contract and approved by the
investment company's Trustees. In addition, voting rights may pass with the
loaned securities, but if a material event were to occur affecting an investment
on loan, the loan must be called and the securities voted.
FOREIGN INVESTMENTS
Investors should recognize that investing in foreign securities involves certain
special considerations which are not typically associated with investing in
domestic securities. Since the securities of foreign issuers are frequently
denominated in foreign currencies, and since the portfolios may temporarily hold
uninvested reserves in bank deposits in foreign currencies, the portfolios will
be affected favorably or unfavorably by changes in currency rates and in
exchange control regulations, and may incur costs in connection with conversions
between various currencies. The investment policies of the portfolios (except
for the Domestic Fixed Income, Limited Duration, Mortgage-Backed Securities,
Advisory Mortgage and Cash Reserves Portfolios) permit them to enter into
forward foreign currency exchange contracts in order to hedge their respective
holdings and commitments against changes in the level of future currency rates.
Such contracts involve an obligation to purchase or sell a specific currency at
a future date at a price set at the time of the contract.
As non-U.S. companies are not generally subject to uniform accounting, auditing
and financial reporting standards and practices comparable to those applicable
to domestic issuers, there may be less publicly available information about
certain foreign securities than about domestic securities. Securities of some
foreign issuers are generally less liquid and more volatile than securities of
comparable domestic companies. There is generally less government supervision
and regulation of stock exchanges, brokers and listed issuers than in the U.S.
In addition, with respect to certain foreign countries, there is the possibility
of expropriation or confiscatory taxation, political or social instability, or
diplomatic developments which could affect U.S. investments in those countries.
Although the portfolios will endeavor to achieve most favorable execution costs
in their portfolio transactions, fixed commissions on many foreign stock
exchanges are generally higher than negotiated commissions on U.S. exchanges. In
addition, it is expected that the expenses for custodian arrangements of the
portfolio's foreign securities will be somewhat greater than the expenses for
the custodian arrangements for handling the U.S. securities of equal value.
Certain foreign governments levy withholding taxes against dividend and interest
income. Although in some countries a portion of these taxes is recoverable, the
non-recovered portion of foreign withholding taxes will reduce the income
received from investments in such countries. However, these foreign withholding
taxes are not expected to have a significant impact on those portfolios for
which the investment objective is to seek long-term capital appreciation and any
income should be considered incidental.
The International Equity, Emerging Markets Value, International Fixed Income,
Advisory Foreign Fixed Income, Global Fixed Income, Multi-Asset-Class, High
Yield, Municipal, PA Municipal, Balanced Plus, Balanced, and Multi-Market Fixed
Income Portfolios may invest in the securities of issuers in Eastern
4
European and other developing markets. The economies of these countries are
currently suffering both from the stagnation resulting from centralized economic
planning and control and the higher prices and unemployment associated with the
transition to market economies. Unstable economic and political conditions may
adversely affect security values. Upon the accession to power of Communist
regimes approximately 50 years ago, the governments of a number of Eastern
European countries expropriated a large amount of property. The claims of many
property owners against those governments were never finally settled. As a
result, there can be no assurance that a portfolio's investments in Eastern
Europe would not also be expropriated, nationalized or otherwise confiscated.
In addition, the Equity, Growth, International Equity, Mid Cap Growth, Mid Cap
Value, Small Cap Value, Value, Balanced. Multi-Asset-Class and Balanced Plus
Portfolios may invest in Global Depositary Receipts ("GDRs") and European
Depositary Receipts ("EDRs") to the extent that they come available. GDRs and
EDRs are typically issued by foreign depositaries, and evidence ownership
interests in a security or pool of securities issued by either a foreign or a
U.S. corporation.
Holders of unsponsored GDRs and EDRs generally bear all the costs associated
with establishing the unsponsored GDRs and EDRs. The depositary of unsponsored
GDRs and EDRs is under no obligation to distribute shareholder communications
received from the underlying issuer or to pass through to the holders of the
unsponsored GDRs and EDRs voting rights with respect to the deposited securities
or pool of securities. GDRs and EDRs are not necessarily denominated in the same
currency as the underlying securities to which they may be connected. Generally,
GDRs or EDRs in registered form are designed for use in the U.S. securities
market and GDRs or EDRs in bearer form are designed for use in securities
markets outside the U.S.. The above portfolios may invest in sponsored and
unsponsored GDRs and EDRs. For purposes of the Funds' investment policies, a
portfolio's investments in GDRs or EDRs will be deemed to be investments in the
underlying securities.
FUTURES CONTRACTS
Each portfolio, except the Cash Reserves Portfolio, may enter into futures
contracts, options, and options on futures contracts. Futures contracts provide
for the future sale by one party and purchase by another party of a specified
amount of a specific security at a specified future time and at a specified
price. Futures contracts which are standardized as to maturity date and
underlying financial instrument are traded on national futures exchanges.
Futures exchanges and trading are regulated under the Commodity Exchange Act by
the Commodity Futures Trading Commission ("CFTC"), a U.S. Government agency.
Although futures contracts by their terms call for actual delivery or acceptance
of the underlying securities, in most cases the contracts are closed out before
the settlement date without the making or taking of delivery. Closing out an
open futures position is done by taking an opposite position ("buying" a
contract which has previously been "sold" or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
acceptable securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying securities)
if it is not terminated prior to the specified delivery date. Minimum initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on the basis of
margin deposits that may range upward from less than 5% of the value of the
contract being traded. A portfolio's margin deposits will be placed in a
segregated account maintained by the Fund's Custodian or with a futures
commission merchant as approved by the Fund's Board of Trustees.
5
After a futures contract position is opened, the value of the contract is marked
to market daily. If the futures contract price changes to the extent that the
margin on deposit does not satisfy margin requirements, payment of additional
"variation" margin will be required. Conversely, a change in the contract value
may reduce the required margin, resulting in a repayment of excess margin to the
contract holder. Variation margin payments are made to and from the futures
broker for as long as the contract remains open. The Fund expects to earn
interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers" or
"speculators." Hedgers use the futures markets primarily to offset unfavorable
changes in the value of securities otherwise held for investment purposes or
expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade, and use futures
contracts with the expectation of realizing profits from fluctuations in the
value of the underlying securities. Regulations of the CFTC applicable to the
Fund require that the aggregate initial margins and premiums required to
establish non-hedging positions not exceed 5% of the liquidation value of a
portfolio.
Although techniques other than the sale and purchase of futures contracts could
be used to control a portfolio's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the portfolios will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
A portfolio will not enter into futures contracts to the extent that its
outstanding obligations to purchase securities under these contracts in
combination with its outstanding obligations with respect to options
transactions would exceed 50% of its total assets, and will maintain assets
sufficient to meet its obligations under such contracts in a segregated account
with the custodian bank or will otherwise comply with the SEC's position on
asset coverage.
RISK FACTORS IN FUTURES TRANSACTIONS
Positions in futures contracts may be closed out only on an exchange which
provides a secondary market for such futures. However, there can be no assurance
that a liquid secondary market will exist for any particular futures contract at
any specific time. Thus, it may not be possible to close a futures position. In
the event of adverse price movements, a portfolio would continue to be required
to make daily cash payments to maintain its required margin. In such situations,
if the portfolio has insufficient cash, it may have to sell portfolio securities
to meet daily margin requirements at a time when it may be disadvantageous to do
so. In addition, the portfolio may be required to make delivery of the
instruments underlying interest rate futures contracts it holds. The inability
to close options and futures positions also could have an adverse impact on a
portfolio's ability to effectively hedge. A portfolio will minimize the risk
that it will be unable to close out a futures contract by only entering into
futures which are traded on national futures exchanges and for which there
appears to be a liquid secondary market.
The risk of loss in trading futures contracts in some strategies can be
substantial, due both to the low margin deposits required and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss (as well as gain) to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a subsequent
10% decrease in the value of the futures contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit if the contract were closed out. Thus, a
6
purchase or sale of a futures contract may result in losses in excess of the
amount invested in the contract. A portfolio would presumably have sustained
comparable losses if, instead of the futures contract, it had invested in the
underlying financial instrument and sold it after the decline.
Utilization of futures transactions by a portfolio does involve the risk of
imperfect or no correlation where the securities underlying futures contracts
have different maturities than the portfolio securities being hedged. It is also
possible that a portfolio could both lose money on futures contracts and also
experience a decline in value of its portfolio securities. There is also the
risk of loss by a portfolio of margin deposits in the event of bankruptcy of a
broker with whom the portfolio has an open position in a futures contract or
related option. Most futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. The daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no trades may be made on that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses, because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
OPTIONS
Investments in options involve some of the same considerations that are involved
in connection with investments in futures contracts (e.g., the existence of a
liquid secondary market). In addition, the purchase of an option also entails
the risk that changes in the value of the underlying security or contract will
not be fully reflected in the value of the option purchased. Depending on the
pricing of the option compared to either the futures contract or securities, an
option may or may not be less risky than ownership of the futures contract or
actual securities. In general, the market prices of options can be expected to
be more volatile than the market prices on the underlying futures contract or
securities.
OTC Options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all the terms of an
OTC Option, including such terms as method of settlement, term, exercise price,
premium, guarantees and security, are set by negotiation of the parties. The
portfolios expect generally to enter into OTC Options that have cash settlement
provisions, although it is not required to do so.
Unless the parties provide for it, there is no central clearing or guaranty
function in an OTC Option. As a result, if the Counterparty fails to make or
take delivery of the security, currency or other instrument underlying an OTC
Option it has entered into with a portfolio or fails to make a cash settlement
payment due in accordance with the terms of that option, the portfolio will lose
any premium it paid for the option as well as any anticipated benefit of the
transaction. Accordingly, the Adviser must assess the creditworthiness of each
such Counterparty or any guarantor of credit enhancement of the Counterparty's
credit to determine the likelihood that the terms of the OTC Option will be
satisfied. The staff of the SEC currently takes the position that OTC Options
purchased by the portfolios or sold by them (the cost of the sell-back plus the
in-the-money amount, if any) are illiquid, and are subject to each portfolio's
limitation on investing in illiquid securities.
The portfolios may also write covered-call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for cross-hedging
purposes if it is designed to protect against a decline in the U.S. dollar value
of a currency due to the changes of exchange rates vis a vis the U.S. dollar and
the option is written for a currency other than the currency in which the
security is denominated. In such circumstances, the portfolios will follow the
coverage requirements as described in the preceding paragraph.
7
OPTIONS ON FOREIGN CURRENCIES
All portfolios, except the Cash Reserves, Domestic Fixed Income, Limited
Duration, Mortgage-Backed Securities and Advisory Mortgage Portfolios, may
purchase and write options on foreign currencies in a manner similar to that in
which futures contracts on foreign currencies, or forward contracts, will be
utilized. For example, a decline in the dollar value of a foreign currency in
which portfolio securities are denominated will reduce the dollar value of such
securities, even if their value in the foreign currency remains constant. In
order to protect against such diminution in the value of portfolio securities, a
portfolio may purchase put options on the foreign currency. If the value of the
currency does decline, a portfolio will have the right to sell such currency for
a fixed amount in dollars and will thereby offset, in whole or in part, the
adverse effect on its portfolio which otherwise would have resulted.
Conversely, where a rise in the dollar value of a currency in which securities
to be acquired are denominated is projected, thereby increasing the cost of such
securities, a portfolio may purchase call options thereon. The purchase of such
options could offset, at least partially, the effects of the adverse movements
in exchange rates. As in the case of other types of options, however, the
benefit to a portfolio derived from purchases of foreign currency options will
be reduced by the amount of the premium and related transaction costs. In
addition, where currency exchange rates do not move in the direction or to the
extent anticipated, the portfolios could sustain losses on transactions in
foreign currency options which would require them to forego a portion or all of
the benefits of advantageous changes in such rates.
The portfolios may write options on foreign currencies for the same purposes.
For example, where a portfolio anticipates a decline in the dollar value of
foreign currency denominated securities due to adverse fluctuations in exchange
rates it could, instead of purchasing a put option, write a call option on the
relevant currency. If the anticipated decline occurs, the option will most
likely not be exercised, and the diminution in value of portfolio securities
will be offset by the amount of the premium received.
Similarly, instead of purchasing a call option to hedge against an anticipated
increase in the dollar cost of securities to be acquired, a portfolio could
write a put option on the relevant currency which, if rates move in the manner
projected, will expire unexercised and allow the portfolio to hedge such
increased cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute only
a partial hedge up to the amount of the premium, and only if rates move in the
expected direction. If this does not occur, the option may be exercised and the
portfolio would be required to purchase or sell the underlying currency at a
loss which may not be offset by the amount of the premium. Through the writing
of options on foreign currencies, a portfolio also may be required to forego all
or a portion of the benefits which might otherwise have been obtained from
favorable movements in exchange rates.
The portfolios may only write covered call options on foreign currencies. A call
option written on a foreign currency by a portfolio is "covered" if the
portfolio owns the underlying foreign currency covered by the call, an absolute
and immediate right to acquire that foreign currency without additional cash
consideration (or for additional cash consideration held in a segregated account
by the Custodian) or upon conversion or exchange of other foreign currency held
in its portfolio. A written call option is also covered if a portfolio has a
call on the same foreign currency and in the same principal amount as the call
written where the exercise price of the call held (a) is equal to or less than
the exercise price of the call written or (b) is greater than the exercise price
of the call written if the difference is maintained by the portfolio in cash or
liquid securities in a segregated account with the Custodian, or (c) maintains
in a segregated account cash or liquid securities in an amount not less than the
value of the underlying foreign currency in U.S. dollars, marked-to-market
daily.
The portfolios may also write call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for cross-hedging
purposes if it is designed to provide a hedge against a decline in the
8
U.S. dollar value of a security which a portfolio owns or has the right to
acquire due to an adverse change in the exchange rate and which is denominated
in the currency underlying the option. In such circumstances, the portfolio will
either "cover" the transaction as described above or collateralize the option by
maintaining in a segregated account with the Custodian, cash or liquid
securities in an amount not less than the value of the underlying foreign
currency in U.S. dollars marked-to-market daily.
COMBINED TRANSACTIONS
The portfolios may enter into multiple transactions, including multiple options
transactions, multiple futures transactions, multiple foreign currency
transactions (including forward foreign currency exchange contracts) and any
combination of futures, options and foreign currency transactions, instead of a
single transaction, as part of a single hedging strategy when, in the opinion of
the Adviser, it is in the best interest of the portfolio to do so. A combined
transaction, while part of a single strategy, may contain elements of risk that
are present in each of its component transactions and will be structured in
accordance with applicable SEC regulations and SEC staff guidelines.
RISKS OF OPTIONS ON FUTURES CONTRACTS, FORWARD CONTRACTS AND OPTIONS ON
FOREIGN CURRENCIES
Options on foreign currencies and forward contracts are not traded on contract
markets regulated by the CFTC or (with the exception of certain foreign currency
options) by the SEC. To the contrary, such instruments are traded through
financial institutions acting as market-makers, although foreign currency
options are also traded on certain national securities exchanges, such as the
Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to
SEC regulation. Similarly, options on currencies may be traded over-the-counter.
In an over-the-counter trading environment, many of the protections afforded to
exchange participants will not be available. For example, there are no daily
price fluctuation limits, and adverse market movements could therefore continue
to an unlimited extent over a period of time. Although the purchase of an option
cannot lose more than the amount of the premium plus related transaction costs,
this entire amount could be lost. Moreover, the option writer and a trader of
forward contracts could lose amounts substantially in excess of their initial
investments, due to the margin and collateral requirements associated with such
positions.
Options on foreign currencies traded on national securities exchanges are within
the jurisdiction of the SEC, as are other securities traded on such exchanges.
As a result, many of the protections provided to traders on organized exchanges
will be available with respect to such transactions. In particular, all foreign
currency option positions entered into on a national securities exchange are
cleared and guaranteed by the Options Clearing Corporation ("OCC"), thereby
reducing the risk of counterparty default. Furthermore, a liquid secondary
market in options traded on a national securities exchange may be more readily
available than in the over-the-counter market, potentially permitting a
portfolio to liquidate open positions at a profit prior to exercise or
expiration, or to limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options, however, are
subject to the risks of the availability of a liquid secondary market described
above, as well as the risks regarding adverse market movements, margining of
options written, the nature of the foreign currency market, possible
intervention by governmental authorities and the effect of other political and
economic events. In addition, exchange-traded options of foreign currencies
involve certain risks not presented by the over-the-counter market. For example,
exercise and settlement of such options must be made exclusively through the
OCC, which has established banking relationships in applicable foreign countries
for this purpose. As a result, the OCC may, if it determines that foreign
governmental restrictions or taxes would prevent the orderly settlement of
foreign currency option exercises, or would result in undue burdens on the OCC
or its clearing member, impose special
9
procedures on exercise and settlement, such as technical changes in the
mechanics of delivery of currency, the fixing of dollar settlement prices or
prohibitions, on exercise.
In addition, futures contracts, options on futures contracts, forward contracts
and options on foreign currencies may be traded on foreign exchanges. Such
transactions are subject to the risk of governmental actions affecting trading
in or the prices of foreign currencies or securities. The value of such
positions also could be adversely affected by (i) other complex foreign
political and economic factors, (ii) lesser availability than in the U.S. of
data on which to make trading decisions, (iii) delays in a portfolio's ability
to act upon economic events occurring in foreign markets during non business
hours in the U.S., (iv) the imposition of different exercise and settlement
terms and procedures and margin requirements than in the U.S., and (v) lesser
trading volume.
SWAP CONTRACTS
All portfolios, except the Cash Reserves and Mid Cap Growth Portfolios, may
enter into Swap Contracts. A swap is an agreement to exchange the return
generated by one instrument for the return generated by another instrument. The
payment streams are calculated by reference to a specified index and agreed upon
notional amount. The term "specified index" includes currencies, fixed interest
rates, prices, total return on interest rate indices, fixed income indices,
stock indices and commodity indices (as well as amounts derived from arithmetic
operations on these indices). For example, a portfolio may agree to swap the
return generated by a fixed-income index for the return generated by a second
fixed-income index. The currency swaps in which the portfolios may enter will
generally involve an agreement to pay interest streams in one currency based on
a specified index in exchange for receiving interest streams denominated in
another currency. Such swaps may involve initial and final exchanges that
correspond to the agreed upon national amount.
The swaps in which the portfolios may engage also include rate caps, floors and
collars under which one party pays a single or periodic fixed amount(s) (or
premium), and the other party pays periodic amounts based on the movement of a
specified index. Swaps do not involve the delivery of securities, other
underlying assets, or principal. Accordingly, the risk of loss with respect to
swaps is limited to the net amount of payments that a portfolio is contractually
obligated to make. If the other party to a swap defaults, a portfolio's risk of
loss consists of the net amount of payments that a portfolio is contractually
entitled to receive. Currency swaps usually involve the delivery of the entire
principal value of one designated currency in exchange for the other designated
currency. Therefore, the entire principal value of a currency swap is subject to
the risk that the other party to the swap will default on its contractual
delivery obligations. If there is a default by the Counterparty, the portfolios
may have contractual remedies pursuant to the agreements related to the
transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps, floors, and collars are more recent
innovations for which standardized documentation has not yet been fully
developed and, accordingly, they are less liquid than swaps.
The portfolios will usually enter into swaps on a net basis, i.e., the two
payment streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with a portfolio receiving or paying, as the case
may be, only the net amount of the two payments. A portfolio's obligations under
a swap agreement will be accrued daily (offset against any amounts owing to the
portfolio) and any accrued but unpaid net amounts owed to a swap Counterparty
will be covered by the maintenance of a segregated account consisting of cash or
liquid securities to avoid any potential leveraging of the portfolio. To the
extent that these swaps, caps, floors, and collars are entered into for hedging
purposes, the Adviser believes such obligations do not constitute "senior
securities" under the 1940 Act and, accordingly, will not treat them as being
subject to a portfolio's borrowing restrictions. All of the portfolios of MAS
Funds except the Cash Reserves Portfolio may enter into OTC Derivatives
transactions (swaps, caps, floors, puts, etc., but excluding foreign exchange
contracts) with Counterparties that are approved by the Adviser in accordance
with guidelines established by the Board of
10
Trustees. These guidelines provide for a minimum credit rating for each
Counterparty and various credit enhancement techniques (for example,
collateralization of amounts due from Counterparties) to limit exposure to
Counterparties with ratings below AA.
The use of swaps is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary portfolio
securities transactions. If the Adviser is incorrect in its forecasts of market
values, interest rates, and currency exchange rates, the investment performance
of the portfolios would be less favorable than it would have been if this
investment technique were not used.
FOREIGN CURRENCY EXCHANGE-RELATED SECURITIES
Foreign currency warrants--Foreign currency warrants are warrants which entitle
the holder to receive from the issuer an amount of cash (generally, for warrants
issued in the U.S., in U.S. dollars) which is calculated pursuant to a
predetermined formula and based on the exchange rate between a specified foreign
currency and the U.S. dollar as of the exercise date of the warrant. Foreign
currency warrants generally are exercisable upon their issuance and expire as of
a specified date and time. Foreign currency warrants have been issued in
connection with U.S. dollar-denominated debt offerings by major corporate
issuers in an attempt to reduce the foreign currency exchange risk which, from
the point of view of prospective purchasers of the securities, is inherent in
the international fixed-income marketplace. Foreign currency warrants may
attempt to reduce the foreign exchange risk assumed by purchasers of a security
by, for example, providing for a supplemental payment in the event that the U.S.
dollar depreciates against the value of a major foreign currency such as the
Japanese Yen or German Deutschmark. The formula used to determine the amount
payable upon exercise of a foreign currency warrant may make the warrant
worthless unless the applicable foreign currency exchange rate moves in a
particular direction (e.g., unless the U.S. dollar appreciates or depreciates
against the particular foreign currency to which the warrant is linked or
indexed). Foreign currency warrants are severable from the debt obligations with
which they may be offered, and may be listed on exchanges. Foreign currency
warrants may be exercisable only in certain minimum amounts, and an investor
wishing to exercise warrants who possesses less than the minimum number required
for exercise may be required either to sell the warrants or to purchase
additional warrants, thereby incurring additional transaction costs. In the case
of any exercise of warrants, there may be a time delay between the time a holder
of warrants gives instructions to exercise and the time the exchange rate
relating to exercise is determined, during which time the exchange rate could
change significantly, thereby affecting both the market and cash settlement
values of the warrants being exercised. The expiration date of the warrants may
be accelerated if the warrants should be delisted from an exchange or if their
trading should be suspended permanently, which would result in the loss of any
remaining "time value" of the warrants (i.e., the difference between the current
market value and the exercise value of the warrants), and, in the case where the
warrants were "out-of-the-money," in a total loss of the purchase price of the
warrants. Warrants are generally unsecured obligations of their issuers and are
not standardized foreign currency options issued by the OCC. Unlike foreign
currency options issued by the OCC, the terms of foreign exchange warrants
generally will not be amended in the event of governmental or regulatory actions
affecting exchange rates or in the event of the imposition of other regulatory
controls affecting the international currency markets. The initial public
offering price of foreign currency warrants is generally considerably in excess
of the price that a commercial user of foreign currencies might pay in the
interbank market for a comparable option involving significantly larger amounts
of foreign currencies. Foreign currency warrants are subject to complex
political or economic factors.
Principal exchange rate linked securities--Principal exchange rate linked
securities are debt obligations the principal on which is payable at maturity in
an amount that may vary based on the exchange rate between the U.S. dollar and a
particular foreign currency at or about that time. The return on "standard"
principal exchange rate linked securities is enhanced if the foreign currency to
which the security is linked appreciates against the U.S. dollar, and is
adversely affected by increases in the foreign exchange value of the U.S.
dollar; "reverse"
11
principal exchange rate linked securities are like the "standard" securities,
except that their return is enhanced by increases in the value of the U.S.
dollar and adversely impacted by increases in the value of foreign currency.
Interest payments on the securities are generally made in U.S. dollars at rates
that reflect the degree of foreign currency risk assumed or given up by the
purchaser of the notes (i.e., at relatively higher interest rates if the
purchaser has assumed some of the foreign exchange risk, or relatively lower
interest rates if the issuer has assumed some of the foreign exchange risk,
based of the expectations of the current market). Principal exchange rate linked
securities may in limited cases be subject to acceleration of maturity
(generally, not without the consent of the holders of the securities), which may
have an adverse impact on the value of the principal payment to be made at
maturity.
Performance indexed paper--Performance indexed paper is U.S. dollar-denominated
commercial paper the yield of which is linked to certain foreign exchange rate
movements. The yield to the investor on performance indexed paper is between the
U.S. dollar and a designated currency as of or about that time (generally, the
index maturity two days prior to maturity). The yield to the investor will be
within a range stipulated at the time of purchase of the obligation, generally
with a guaranteed minimum rate of return that is below, and a potential maximum
rate of return that is above, market yields on U.S. dollar-denominated
commercial paper, with both the minimum and maximum rates of return on the
investment corresponding to the minimum and maximum values of the spot exchange
rate two business days prior to maturity.
MUNICIPAL BONDS
Municipal Bonds generally include debt obligations issued by states and their
political subdivisions, and duly constituted authorities and corporations, to
obtain funds to construct, repair or improve various public facilities such as
airports, bridges, highways, hospitals, housing, schools, streets and water and
sewer works. Municipal Bonds may also be issued to refinance outstanding
obligations as well as to obtain funds for general operating expenses and for
loans to other public institutions and facilities.
The two principal classifications of Municipal Bonds are "general obligation"
and "revenue" or "special tax" 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 or special tax bonds are payable only from
the revenues derived from a particular facility or class of facilities or, in
some cases, from the proceeds of a special excise or other tax, but not from
general tax revenues. The Municipal and PA Municipal Portfolios ("the
portfolios") may also invest in tax-exempt industrial development bonds,
short-term municipal obligations, project notes, demand notes and tax-exempt
commercial paper.
Industrial revenue bonds in most cases are revenue bonds and generally do not
have the pledge of the credit of the issuer. The payment of the principal and
interest on such industrial revenue bonds is dependent solely on the ability of
the user of the facilities financed by the bonds to meet its financial
obligations and the pledge, if any, of real and personal property so financed as
security for such payment. Short-term municipal obligations issued by states,
cities, municipalities or municipal agencies, include Tax Anticipation Notes,
Revenue Anticipation Notes, Bond Anticipation Notes, Construction Loan Notes and
Short-Term Discount Notes. Project Notes are instruments issued by the
Department of Housing and Urban Development but issued by a state or local
housing agency. While the issuing agency has the primary obligation on such
Project notes, they are also secured by the full faith and credit of the U.S..
Note obligations with demand or put options may have a stated maturity in excess
of one year, but permit any holder to demand payment of principal plus accrued
interest upon a specified number of days' notice. Frequently, such obligations
are secured by letters of credit or other credit support arrangements provided
by banks. The issuer of such notes normally has a corresponding right, after a
given period, to repay at its discretion the outstanding principal of the note
plus accrued interest upon a specific number of days' notice to
12
the bondholders. The interest rate on a demand note may be based upon a known
lending rate, such as the prime lending rate, and be adjusted when such rate
changes, or the interest rate on a demand note may be a market rate that is
adjusted at specified intervals. Each note purchased by the portfolios will meet
the quality criteria set out in the prospectus for the portfolios.
The yields of Municipal Bonds depend on, among other things, general money
market conditions, conditions in the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of Moody's and Standard & Poor's represent their opinions of
the quality of the Municipal Bonds rated by them. It should be emphasized that
such ratings are general and are not absolute standards of quality.
Consequently, Municipal Bonds with the same maturity, coupon and rating may have
different yields, while Municipal Bonds of the same maturity and coupon, but
with different ratings may have the same yield. It will be the responsibility of
the investment management staff to appraise independently the fundamental
quality of the bonds held by the portfolios.
Municipal Bonds are sometimes purchased on a "when-issued" basis meaning the
portfolio has committed to purchase certain specified securities at an agreed
upon price when they are issued. The period between commitment date and issuance
date can be a month or more. It is possible that the securities will never be
issued and the commitment canceled.
From time to time proposals have been introduced before Congress to restrict or
eliminate the federal income tax exemption for interest on Municipal Bonds.
Similar proposals may be introduced in the future. If any such proposal were
enacted, it might restrict or eliminate the ability of the portfolios to achieve
their investment objectives. In that event, the Fund's Trustees and officers
would reevaluate investment objectives and policies and consider recommending to
shareholders changes in such objectives and policies.
Similarly, from time to time proposals have been introduced before state and
local legislatures to restrict or eliminate the state and local income tax
exemption for interest on Municipal Bonds. Similar proposals may be introduced
in the future. If any such proposal were enacted, it might restrict or eliminate
the ability of a portfolio to achieve its investment objective. In that event,
the Fund's Trustees and officers would reevaluate investment objectives and
policies and consider recommending to shareholders changes in such objectives
and policies.
DURATION
The Limited Duration and Intermediate Duration Portfolios seek to achieve their
objectives by investing in the types of fixed income securities described in the
prospectus and by maintaining an average duration of between one and three years
and two and five years, respectively. Duration is one of the fundamental tools
used by the Adviser in security selection for the portfolios and any other
portfolio which invests in fixed income securities.
Duration is a measure of the expected life of a fixed income security that was
developed as a more precise alternative to the concept of the "term of
maturity." Duration incorporates a bond's yield, coupon interest payments, final
maturity and call features into one measure.
Most debt obligations provide interest ("coupon") payments in addition to a
final ("par") payment at maturity. Some obligations also have call provisions.
Depending on the relative magnitude of these payments, the market values of debt
obligations may respond differently to changes in the level and structure of
interest rates.
Traditionally, a debt security's "term to maturity" has been used as a proxy for
the sensitivity of the security's price to changes in interest rates (which is
the "interest rate risk" or "volatility" of the security). However, "term to
maturity" measures only the time until a debt security provides its final
payment, taking no account of the
13
pattern of the security's payments prior to maturity. Duration is a measure of
the expected life of a fixed income security on a present value basis. Duration
takes the length of the time intervals between the present time and the time
that the interest and principal payments are scheduled or, in the case of a
callable bond, expected to be received, and weights them by the present values
of the cash to be received at each future point in time. For any fixed income
security with interest payments occurring prior to the payment of principal,
duration is always less than maturity. In general, all other things being the
same, the lower the stated or coupon rate of interest of a fixed income
security, the longer the duration of the security; conversely, the higher the
stated or coupon rate of interest of a fixed income security, the shorter the
duration of the security.
There are some situations where even the standard duration calculation does not
properly reflect the interest rate exposure of a security. For example, in the
case of mortgage-backed securities, the current prepayment rates are more
critical than their stated final maturities in determining their interest rate
exposure. In these and other similar situations, the Adviser will use more
sophisticated analytical techniques that incorporate the economic life of a
security into the determination of its interest rate exposure.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to investors. Most
issuers or poolers provide guarantees of payments, regardless of whether or not
the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are individual loan, title, pool and hazard insurance purchased by the
issuer. There can be no assurance that the private issuers can meet their
obligations under the policies. Mortgage-backed securities issued by private
issuers, whether or not such securities are subject to guarantees, may entail
greater risk. If there is no guarantee provided by the issuer, mortgage-backed
securities purchased by the portfolios will be rated investment grade by Moody's
or Standard & Poor's, or, if unrated, deemed by the Adviser to be of investment
grade quality.
Underlying Mortgages
Pools consist of whole mortgage loans or participation in loans. The majority of
these loans are made to purchasers of 1-4 family homes. The terms and
characteristics of the mortgage instruments are generally uniform within a pool
but may vary among pools. For example, in addition to fixed-rate fixed-term
mortgages, the portfolios may purchase pools of adjustable rate mortgages (ARM),
growing equity mortgages (GEM), graduated payment mortgage (GPM) and other types
where the principal and interest payment procedures vary. ARM's are mortgages
which reset the mortgage's interest rate with changes in open market interest
rates. The portfolios' interest income will vary with changes in the applicable
interest rate on pools of ARM's. GPM and GEM pools maintain constant interest
rates, with varying levels of principal repayment over the life of the mortgage.
These different interest and principal payment procedures should not impact the
portfolios' net asset values since the prices at which these securities are
valued each day will reflect the payment procedures.
All poolers apply standards for qualifications to local lending institutions
which originate mortgages for the pools. Poolers also establish credit standards
and underwriting criteria for individual mortgages included in the pools. In
addition, many mortgages included in pools are insured through private mortgage
insurance companies.
Average Life
The average life of pass-through pools varies with the maturities, coupon rates,
and type of the underlying mortgage instruments. In addition, a pool's term may
be shortened by unscheduled or early payments of
14
principal and interest on the underlying mortgages. The occurrence of mortgage
prepayments is affected by factors including the level of interest rates,
general economic conditions, the location and age of the mortgage and other
social and demographic conditions.
Returns of Mortgage-Backed Securities
Yields on mortgage-backed pass-through securities are typically quoted based on
a prepayment assumption derived from the coupon and maturity of the underlying
instruments. Actual prepayment experience may cause the realized return to
differ from the assumed yield. Reinvestment of prepayments may occur at higher
or lower interest rates than the original investment, thus affecting the
realized returns of the portfolios. The compounding effect from reinvestment of
monthly payments received by each portfolio will increase its return to
shareholders, compared to bonds that pay interest semi-annually.
About Mortgage-Backed Securities
Interests in pools of mortgage-backed securities differ from other forms of debt
securities, which normally provide for periodic payment of interest in fixed
amounts with principal payments at maturity or specified call dates. Instead,
these securities provide a monthly payment which consists of both interest and
principal payments. In effect, these payments are a "pass-through" of the
monthly payments made by the individual borrowers on their residential mortgage
loans, net of any fees paid to the issuer or guarantor of such securities.
Additional payments are caused by repayments resulting from the sale of the
underlying residential property, refinancing or foreclosure net of fees or costs
which may be incurred. Some mortgage-backed securities are described as
"modified pass-through." These securities entitle the holders to receive all
interest and principal payments owed on the mortgages in the pool, net of
certain fees, regardless of whether or not the mortgagors actually make payment.
Residential mortgage loans are pooled by the Federal Home Loan Mortgage
Corporation (FHLMC). FHLMC is a corporate instrumentality of the U.S. Government
and was created by Congress in 1970 for the purpose of increasing the
availability of mortgage credit for residential housing. FHLMC issues
Participation Certificates ("PC's") which represent interests in mortgages from
FHLMC's national portfolio. FHLMC guarantees the timely payment of interest and
ultimate collection of principal.
Fannie Mae is a Government-sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of Housing
and Urban Development. Fannie Mae purchases residential mortgages from a list of
approved seller/servicers which include state and federally-chartered savings
and loan associations, mutual savings, banks, commercial banks and credit unions
and mortgage bankers. Pass-through securities issued by Fannie Mae are
guaranteed as to timely payment of principal and interest by Fannie Mae.
The principal Government guarantor of mortgage-backed securities is the
Government National Mortgage Association (GNMA). GNMA is a wholly-owned U.S.
Government corporation within the Department of Housing and Urban Development.
GNMA is authorized to guarantee, with the full faith and credit of the U.S.
Government, the timely payment of principal and interest on securities issued by
approved institutions and backed by pools of FHA-insured or VA-guaranteed
mortgages.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
Government and Government-related pools because there are no direct or indirect
Government guarantees of payments in the former pools. However, timely payment
of interest and principal of these pools is supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance purchased by the issuer.
15
The insurance and guarantees are issued by Governmental entities, private
insurers and the mortgage poolers. There can be no assurance that the private
insurers can meet their obligations under the policies. Mortgage-backed
securities purchased for the portfolios will, however, be rated of investment
grade quality by Moody's and/or Standard & Poor's or, if unrated, deemed by the
Adviser to be of investment grade quality.
It is expected that Governmental or private entities may create mortgage loan
pools offering pass-through investments in addition to those described above.
The mortgages underlying these securities may be alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payment
may vary or whose terms to maturity may be shorter than previously customary. As
new types of mortgage-backed securities are developed and offered to investors,
the portfolios will, consistent with their investment objective and policies,
consider making investments in such new types of securities.
STRIPPED MORTGAGE-BACKED SECURITIES
Stripped mortgage-backed securities ("SMBS") are derivative multiclass mortgage
securities. SMBS may be issued by agencies or instrumentalities of the U.S.
Government or by private originators of, or investors in, mortgage loans,
including savings and loan associations, mortgage banks, commercial banks,
investment banks and special purpose entities of the foregoing.
SMBS are usually structured with two classes that receive different proportions
of the interest and principal distributions on a pool of mortgage assets. A
common type of SMBS will have one class receiving some of the interest and most
of the principal from the mortgage assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the interest-only or "IO"
class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yield to maturity on an IO class is extremely
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on a portfolio's yield to maturity from these
securities. If the underlying mortgage assets experience greater than
anticipated prepayments of principal, a portfolio may fail to fully recoup its
initial investment in these securities even if the security is in one of the
highest rating categories.
SMBS are generally purchased and sold by institutional investors through several
investment banking firms acting as brokers or dealers. Certain of these
securities may be deemed "illiquid" and subject to each portfolio's limitation
on investing in illiquid securities.
U.S. GOVERNMENT SECURITIES
The term "U.S. Government securities" refers to a variety of securities which
are issued or guaranteed by the U.S. Government, and by various
instrumentalities which have been established or sponsored by the U.S.
Government. U.S. Treasury securities are backed by the "full faith and credit"
of the U.S.
Agency Securities: Securities issued or guaranteed by federal agencies and U.S.
Government sponsored instrumentalities may or may not be backed by the full
faith and credit of the U.S. In the case of securities not backed by the full
faith and credit of the U.S., the investor must look principally to the agency
or instrumentality issuing or guaranteeing the obligation for ultimate
repayment, and may not be able to assert a claim against the U.S. itself in the
event the agency or instrumentality does not meet its commitment. Agencies which
are backed by the full faith and credit of the U.S. include the Export Import
Bank, Farmers Home Administration, Federal Financing Bank, and others. Certain
debt issued by Resolution Funding Corporation has both its principal and
interest backed by the full faith and credit of the U.S. Treasury in that its
principal is defeased by U.S. Treasury zero coupon issues, while the U.S.
Treasury is explicitly required to advance funds sufficient to pay interest on
it, if needed. Certain agencies and instrumentalities, such as the
16
Government National Mortgage Association, are, in effect, backed by the full
faith and credit of the U.S. through provisions in their charters that they may
make "indefinite and unlimited" drawings on the Treasury, if needed to service
its debt. Debt from certain other agencies and instrumentalities, including the
Federal Home Loan Bank and Fannie Mae, are not guaranteed by the U.S., but those
institutions are protected by the discretionary authority of the U.S. Treasury
to purchase certain amounts of their securities to assist the institution in
meeting its debt obligations. Finally, other agencies and instrumentalities,
such as the Farm Credit System and the Federal Home Loan Mortgage Corporation,
are federally chartered institutions under Government supervision, but their
debt securities are backed only by the credit worthiness of those institutions,
not the U.S. Government.
Some of the U.S. Government agencies that issue or guarantee securities include
the Export-Import Bank of the United States, Farmers Home Administration,
Federal Housing Administration, Maritime Administration, Small Business
Administration and The Tennessee Valley Authority.
An instrumentality of the U.S. Government is a Government agency organized under
federal charter with Government supervision. Instrumentalities issuing or
guaranteeing securities include, among others, Federal Home Loan Banks, the
Federal Land Banks, Central Bank for Cooperatives, Federal Intermediate Credit
Banks and Fannie Mae.
ZERO COUPON BONDS
Zero Coupon Bonds is a term used to describe notes and bonds which have been
stripped of their unmatured interest coupons, or the coupons themselves, and
also receipts or certificates representing interest in such stripped debt
obligations and coupons. The timely payment of coupon interest and principal on
these instruments remains guaranteed by the issuer.
A Zero Coupon Bond does not pay interest. Instead, it is issued at a substantial
discount to its "face value"-- what it will be worth at maturity. The difference
between a security's issue or purchase price and its face value represents the
imputed interest an investor will earn if the security is held until maturity.
For tax purposes, a portion of this imputed interest is deemed as income
received by zero coupon bondholders each year. The Fund, which expects to
qualify as a regulated investment company, intends to pass along such interest
as a component of the portfolio's distributions of net investment income.
Zero Coupon Bonds may offer investors the opportunity to earn higher yields than
those available on other bonds of similar maturity. However, zero coupon bond
prices may also exhibit greater price volatility than ordinary debt securities
because of the manner in which their principal and interest is returned to the
investor.
Zero Coupon Treasury Bonds are sold under a variety of different names, such as:
Certificate of Accrual on Treasury Securities (CATS), Treasury Receipts (TRS),
Separate Trading of Registered Interest and Principal of Securities (STRIPS) and
Treasury Investment Growth Receipts (TIGERS).
EURODOLLAR AND YANKEE OBLIGATIONS
Each portfolio, except the Domestic Fixed Income Portfolio, can invest in
Eurodollar and Yankee obligations. Eurodollar bank obligations are
dollar-denominated certificates of deposit and time deposits issued outside the
U.S. capital markets by foreign branches of U.S. banks and by foreign banks.
Yankee bank obligations are dollar-denominated obligations issued in the U.S.
capital markets by foreign banks.
Eurodollar and Yankee obligations are subject to the same risks that pertain to
domestic issues, notably credit risk, market risk and liquidity risk.
Additionally, Eurodollar (and to a limited extent, Yankee) obligations are
17
subject to certain sovereign risks. One such risk is the possibility that a
sovereign country might prevent capital, in the form of dollars, from flowing
across their borders. Other risks include: adverse political and economic
developments; the extent and quality of government regulation of financial
markets and institutions; the imposition of foreign withholding taxes, and the
expropriation or nationalization of foreign issuers. However, Eurodollar and
Yankee obligations held in the Cash Reserves Portfolio will undergo the same
credit analysis as domestic issues in which the Cash Reserves Portfolio invests,
and will have at least the same financial strength as the domestic issuers
approved for the Cash Reserves Portfolio.
BRADY BONDS
A portion of certain of the Fund's fixed-income investments may be invested in
certain debt obligations customarily referred to as "Brady Bonds", which are
created through the exchange of existing commercial bank loans to foreign
entities for new obligations in connection with debt restructuring under a plan
introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady (the
"Brady Plan").
Brady Bonds have been issued fairly recently, and, accordingly, do not have a
long payment history. They may be collateralized or uncollateralized and issued
in various currencies (although most are dollar-denominated) and they are
actively traded in the over-the-counter secondary market.
Dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are generally collateralized in full as
to principal due at maturity by U.S. Treasury Zero Coupon Obligations which have
the same maturity as the Brady Bonds. Interest payments on these Brady Bonds
generally are collateralized by cash or securities in an amount that, in the
case of fixed rate bonds, is equal to at least one year of rolling interest
payments or, in the case of floating rate bonds, initially is equal to at least
one year's rolling interest payments based on the applicable interest rate at
that time and is adjusted at regular intervals thereafter. Certain Brady Bonds
are entitled to "value recovery payments" in certain circumstances, which in
effect constitute supplemental interest payments but generally are not
collateralized. Brady Bonds are often viewed as having three or four valuation
components: (i) the collateralized repayment of principal at final maturity;
(ii) the collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk"). In the event of
a default with respect to collateralized Brady Bonds as a result of which the
payment obligations of the issuer are accelerated, the U.S. Treasury Zero Coupon
Obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, in light of the residual risk of the Brady Bonds
and, among other factors, the history of default with respect to commercial bank
loans by public and private entities of countries issuing Brady Bonds,
investments in Brady Bonds are to be viewed as speculative.
CASH RESERVES PORTFOLIO
A-1 and Prime-1 Commercial Paper Ratings: Commercial paper rated A-1 by Standard
& Poor's has the following characteristics: (1) liquidity ratios are adequate to
meet cash requirements; (2) long-term senior debt is rated "A" or better; (3)
the issuer has access to at least two additional channels of borrowing; (4)
basic earnings and cash flow have an upward trend with allowance made for
unusual circumstances; (5) typically, the issuer's industry is well established
and the issuer has a strong position within the industry; and (6) the
reliability and quality of management are unquestioned. Relative strength or
weakness of the above factors determine whether the issuer's commercial paper is
A-1, A-2, or A-3. The rating Prime-1 is the highest commercial paper rating
assigned by Moody's. Among the factors considered by Moody's in assigning
ratings
18
are the following: (1) evaluation of the management of the issuer; (2) economic
evaluation of the issuer's industry or industries and the appraisal of
speculative-type risks which may be inherent in certain areas; (3) evaluation of
the issuer's products in relation to competition and customer acceptance; (4)
liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over
a period of ten years; (7) financial strength of a parent company and the
relationships which exist with the issuer; and (8) recognition by the management
of obligations which may be present or may arise as a result of public interest
questions and preparations to meet such obligations.
TAX CONSIDERATIONS
In order for a portfolio to continue to qualify for federal income tax treatment
as a regulated investment company, at least 90% of its gross income for a
taxable year must be derived from qualifying income; i.e., dividends, interest,
income derived from loans of securities, and gains from the sale of securities
or foreign currencies, or other income derived with respect to its business of
investing in such securities or currencies. It is anticipated that any net gain
realized from the closing out of futures contracts will be considered gain from
the sale of securities and therefore be qualifying income for purposes of the
90% requirement. In addition, (i) a portfolio must distribute annually to its
shareholders at least the sum of 90% of its net interest income excludable from
gross income plus 90% of its investment company taxable income; (ii) at the
close of each quarter of a portfolio's taxable year, at least 50% of its total
assets must be represented by cash and cash items, vs. government securities,
securities of other regulated investment companies and such other securities
with limitations; and (iii) at the close of each quarter of a portfolio's
taxable year, not more than 25% of the value of its assets may be invested in
securities of any one issuer, or of two or more issuers engaged in same or
similar businesses if the portfolio owns at least 20% of the voting power of
such issuers.
Each portfolio of the Fund will distribute to shareholders annually any net
capital gains which have been recognized for federal income tax purposes
including unrealized gains at the end of the portfolio's fiscal year on futures
transactions. Such distributions will be combined with distributions of capital
gains realized on the portfolio's other investments and shareholders will be
advised of the nature of the payments.
The Taxpayer Relief Act of 1997 provides various capital gains rates which
pertain to shareholders who are individuals. Each portfolio will, therefore,
designate distributions derived from capital gains of the portfolio (whether
such distributions are paid in cash or additional shares) as a "20% rate gain
distribution" or a "28% rate gain distribution" in accordance with guidance
issued by the Internal Revenue Service. The Fund will notify shareholders
annually as to the federal tax classification of dividends and distributions
paid by a portfolio including, but not limited to notifying individuals as to
the amount of capital gain distributions subject to the 20% and 28% federal
capital gain tax rates. Distributions of dividends or capital gains may also be
subject to state and local taxes.
Some of the options, futures contracts, forward contracts, and swap contracts
entered into by the portfolios may be "Section 1256 contracts." Section 1256
contracts held by a portfolio at the end of its taxable year (and, for purposes
of the 4% excise tax, on certain other dates as prescribed under the Code) are
"marked to market" with unrealized gains or losses treated as though they were
realized. Any gains or losses, including "marked to market" gains or losses, on
Section 1256 contracts other than forward contracts are generally 60% long-term
and 40% short-term capital gains or losses ("60/40") although all foreign
currency gains and losses from such contracts may be treated as ordinary in
character absent a special election.
Generally, hedging transactions and certain other transactions in options,
futures, forward contracts and swap contracts undertaken by a portfolio, may
result in "straddles" for U.S. federal income tax purposes. The straddle rules
may affect the character of gain or loss realized by a portfolio. In addition,
losses realized by a portfolio on positions that are part of a straddle may be
deferred under the straddle rules, rather than being taken into
19
account in calculating the taxable income for the taxable year in which such
losses are realized. Because only a few regulations implementing the straddle
rules have been promulgated, the tax consequences of transactions in options,
futures, forward contracts, and swap agreements to a portfolio are not entirely
clear. The transactions may increase the amount of short-term capital gain
realized by a portfolio. Short-term capital gain is taxed as ordinary income
when distributed to shareholders.
A portfolio may make one or more of the elections available under the Code which
are applicable to straddles. If a portfolio makes any of the elections, the
amount, character, and timing of the recognition of gains or losses from the
affected straddle positions will be determined under rules that vary according
to the elections made. The rules applicable under certain of the elections
operate to accelerate the recognition of gains or losses from the affected
straddle positions.
Because application of the straddle rules may affect the character of gains or
losses, defer losses and/or accelerate the recognition of gains or losses from
the affected straddle positions, the amount which must be distributed to
shareholders, and which will be taxed to shareholders as ordinary income or
long-term capital gain, may be increased or decreased substantially as compared
to a portfolio that did not engage in such hedging transactions.
The Taxpayer Relief Act of 1997 provides constructive sales treatment for
appreciated financial positions such as stock which has increased in value in
the hands of a portfolio. Under this constructive sales treatment, the portfolio
may be treated as having sold such stock and be required to recognize gain if it
enters into a short sale, an offsetting notional principal contract, a futures
or forward contract, or a similar transaction with respect to such stock or
substantially identical property.
Each portfolio intends to declare and pay dividends and capital gain
distributions so as to avoid imposition of the federal excise tax. To do so,
each portfolio expects to distribute an amount at least equal to (i) 98% of its
calendar year ordinary income, (ii) 98% of its capital gains net income for the
one-year period ending October 31st, and (iii) 100% of any undistributed
ordinary and capital gain net income from the prior year.
Although income received on direct U.S. Government obligations is taxable at the
Federal level, such income is exempt from tax at the state level when received
directly, and may be exempt, depending on the state, when received by a
shareholder. Each portfolio will inform shareholders annually of the percentage
of income and distributions derived from direct U.S. Government obligations.
Shareholders should consult their tax advisers to determine whether any portion
of dividends received from the portfolio is considered tax exempt in their
particular states.
Any gain or loss recognized on a sale or redemption of shares of a portfolio by
a shareholder who is not a dealer in securities will generally be treated as
long-term capital gain or loss if the shares have been held for more than
eighteen months, mid-term if the shares have been held for over one year but not
for over eighteen months, and short-term if for a year or less. Long-term
capital gains are currently taxed at a maximum rate of 20%; mid-term capital
gains are currently taxed at a maximum rate of 28%; and short-term gains are
currently taxed at ordinary income tax rates. If shares held for six months or
less are sold or redeemed for a loss, two special rules apply: First, if shares
on which a net capital gain distribution has been received are subsequently sold
or redeemed, and such shares have been held for six months or less, any loss
recognized will be treated as long-term capital loss to the extent of the
long-term capital gain distributions. Second, any loss recognized by a
shareholder upon the sale or redemption of shares of a municipal portfolio fund
held for six months or less will be disallowed to the extent of any
exempt-interest dividends received by the Shareholder with respect to such
shares.
20
Foreign Income Taxes: Investment income received by the portfolios from sources
within foreign countries may be subject to foreign income taxes withheld at the
source. The U.S. has entered into Tax Treaties with many foreign countries which
would entitle the portfolios to a reduced rate of tax or exemption from tax on
such income. It is impossible to determine the effective rate of foreign tax in
advance since the amount of the portfolios' assets to be invested within various
countries is not known. The portfolios intend to operate so as to qualify for
treaty-reduced rates of tax where applicable.
If more than 50% of a portfolio's assets are represented by foreign securities,
then such portfolio may file an election with the Internal Revenue Service to
pass through to shareholders the amount of foreign income taxes paid by such
portfolio. A portfolio will make such an election only if it is deemed to be in
the best interests of such shareholders.
If a portfolio makes the above-described election, the portfolio will not be
allowed a deduction or a credit for foreign taxes it paid and the amount of such
taxes will be treated as a dividend paid by the portfolio. The shareholders of
the portfolios will be required to: (i) include in gross income, even though not
actually received, their respective pro rata share of foreign taxes paid by the
portfolio; (ii) treat their pro rata share of foreign taxes as paid by them;
(iii) treat as gross income from sources within the respective foreign
countries, for purposes of the foreign tax credit, their pro rata share of such
foreign taxes and their pro rate share of any dividend paid by the portfolio
which represents income from sources within foreign countries; and (iv) either
deduct their pro rata share of foreign taxes in computing their taxable income
or use it within the limitations set forth in the Internal Revenue Code (the
"Code") as a foreign tax credit against U.S. income taxes (but not both). In no
event shall a shareholder be allowed a foreign tax credit if the shareholder
holds shares in a portfolio for 15 days or less during the 30-day period
beginning on the date which is 15 days before the date on which such shares
become ex-dividend with respect to such dividends.
Each shareholder of a portfolio will be notified within 60 days after the close
of each taxable (fiscal) year of the Fund if the Foreign taxes paid by the
portfolio will pass through for that year, and, if so, the amount of each
shareholder's pro rata share (by country) of (i) the foreign taxes paid, and
(ii) the portfolio's gross income from foreign sources. The notice from the
portfolio to shareholders will also include the amount of foreign taxes paid by
the portfolio which are not allowable as a foreign tax credit because the
portfolio did not hold the foreign securities for more than 15 days during the
30-day period beginning on the date which is 15 days before the date on which
the security becomes ex-dividend with respect to the foreign source dividend or
because and to the extent that the recipient of the dividend is under an
obligation to make related payments with respect to positions in substantially
similar or related property. Shareholders who are not liable for federal income
taxes, such as retirement plans qualified under Section 401 of the Code, will
not be affected by any such "pass-through" of foreign tax credits.
Special Tax Considerations for the Municipal and PA Municipal Portfolios: Each
of the Municipal and PA Municipal Portfolios intends that at the close of each
quarter of its taxable year, at least 50% of the value of the portfolio's total
assets will consist of obligations the interest on which is excludable from
gross income (i.e., municipal bonds and notes), so that it may pay
"exempt-interest" dividends to shareholders. Exempt-interest dividends, which
are defined in the Code, are excluded from a shareholder's gross income for
federal income tax purposes, but may nevertheless be subject to the alternative
minimum tax (imposed at a rate of 26%-28% in the case of non-corporate taxpayers
and at the rate of 20% in the case of corporate taxpayers). A shareholder may,
however, lose the federal tax-exempt status of the accrued income of the
portfolio if the shareholder redeems its shares before a dividend has been
declared. Exempt-interest dividends received by shareholders from the
above-referenced portfolios may be subject to state and local taxes, although
some states allow a shareholder to exclude that portion of a portfolio's
tax-exempt income which is accountable to municipal securities issued within the
shareholder's state of residence.
21
These portfolios may invest in private activity municipal securities, the
interest on which is subject to the federal alternative minimum tax for
corporations and individuals and the federal environmental tax for corporations
only. These portfolios may not be an appropriate investment for persons who are
"substantial users" (or persons related to "substantial users") of facilities
financed by industrial development bonds or private activity bonds. A
"substantial user" is defined generally to include certain persons who regularly
use in a trade or business or facility financed from the proceeds of industrial
development bonds or private activity bonds. Such persons should consult their
tax advisers before purchasing shares.
Any distributions received by individual shareholders which are derived from
capital gains of the portfolio will be designated by either portfolio as a "20%
rate gain distribution" or a "28% rate gain distribution" in accordance with
guidance issued by the Internal Revenue Service.
Interest on indebtedness incurred or continued by a shareholder in order to
purchase or carry shares of these portfolios is not deductible for federal
income tax purposes to the extent that it relates to exempt-interest dividends
distributed to the shareholder during the taxable year.
PURCHASE OF SHARES
Each portfolio reserves the right in its sole discretion (i) to suspend the
offering of its shares (ii) to reject purchase orders, and (iii) to reduce or
waive the minimum for initial and subsequent investments. The officers of the
Fund may from time to time waive the minimum initial and subsequent investment
requirements in connection with investments in the Fund by employees of the
Adviser and its affiliates.
REDEMPTION OF SHARES
Each portfolio may suspend redemption privileges or postpone the date of payment
(i) during any period that the New York Stock Exchange ("NYSE") is closed, or
trading on the NYSE is restricted as determined by the SEC, (ii) during any
period when an emergency exists as defined by the rules of the SEC as a result
of which it is not reasonably practicable for a portfolio to dispose of
securities owned by it, or fairly to determine the value of its assets, and
(iii) for such other periods as the SEC may permit.
The Fund has made an election with the SEC pursuant to Rule 18f-1 under the 1940
Act to pay in cash all redemptions requested by any shareholder of record
limited in amount during any 90-day period to the lesser of $250,000 or 1% of
the net assets of the portfolio at the beginning of such period. Such commitment
is irrevocable without the prior approval of the SEC. Redemptions in excess of
the above limits may be paid in whole or in part in investment securities or in
cash, as the Trustees may deem advisable; however, payment will be made wholly
in cash unless the Trustees believe that economic or market conditions exist
which would make such a practice detrimental to the best interests of the Fund.
If redemptions are paid in investment securities, such securities will be valued
as set forth in the Fund's prospectuses under "Valuation of Shares" and a
redeeming shareholder would normally incur brokerage expenses in converting
these securities to cash.
No charge is made by a portfolio for redemptions. Redemption proceeds may be
more or less than the shareholder's cost depending on the market value of the
securities held by the portfolio.
TRANSACTIONS WITH BROKER/DEALERS
The Fund has authorized one or more brokers to accept on its behalf purchase and
redemption orders. These brokers are authorized to designate other
intermediaries to accept purchase and redemption orders on the Fund's behalf.
For purposes of determining the purchase price of shares, the Fund will be
deemed to have received a purchase or redemption order when an authorized
broker, or if applicable, a broker's
22
authorized designee, accepts the order. In other words, orders will be priced at
the net asset value net computed after such orders are accepted by an authorized
broker or the broker's authorized designee.
SHAREHOLDER SERVICES
Exchange Privilege
The exchange privilege is only available with respect to portfolios that are
qualified for sale in a shareholder's state. Exchange requests should be sent to
MAS Funds, c/o Miller Anderson & Sherrerd, LLP, One Tower Bridge, West
Conshohocken, PA 19428-0868. Any such exchange will be based on the respective
net asset values of the shares involved. Before making an exchange, a
shareholder should consider the investment objectives of the portfolio to be
purchased. Exchange requests may be made either by mail or telephone. Telephone
exchanges (referred to as "expedited exchanges") will be accepted only if the
certificates for the shares to be exchanged are held by the Fund for the account
of the shareholder and the registration of the two accounts are identical.
Requests for expedited exchanges received prior to the time at which each
portfolio determines its net asset value, as described in the prospectus will be
processed as of the close of business on the same day. Requests received after
these times will be processed on the next business day. Expedited exchanges may
also be subject to limitations as to amounts or frequency, and to other
restrictions established by the Board of Trustees to assure that such exchanges
do not disadvantage the Fund and its shareholders. The officers of the Fund
reserve the right not to accept any request for an exchange when, in their
opinion, the exchange privilege is being used as a tool for market timing.
For federal income tax purposes, an exchange between portfolios of the Fund is a
taxable event, and, accordingly, a capital gain or loss may be realized. It is
likely, therefore, that a capital gain or loss would be realized on an exchange
between portfolios; you may want to consult your tax adviser for further
information in this regard. The exchange privilege may be modified or terminated
at any time.
Transfer of Shares
Shareholders may transfer shares of the Fund's portfolios to another person by
written request to the Client Services Group at the address noted above. The
request should clearly identify the account and number of shares to be
transferred and include the signature of all registered owners and all share
certificates, if any, which are subject to the transfer. The signature on the
letter of request, the share certificate or any stock power must be guaranteed
in the same manner as described under "Redemption of Shares." As in the case of
redemptions, the written request must be received in good order before any
transfer can be made.
INVESTMENT LIMITATIONS
Each portfolio of the Fund is subject to the following restrictions which are
fundamental policies and may not be changed without the approval of the lesser
of: (1) at least 67% of the voting securities of the portfolio present at a
meeting if the holders of more than 50% of the outstanding voting securities of
the portfolio are present or represented by proxy, or (2) more than 50% of the
outstanding voting securities of the portfolio.
As a matter of fundamental policy, each portfolio will not:
(1) invest in physical commodities or contracts on physical commodities;
23
(2) purchase or sell real estate, although it may purchase and sell securities
of companies which deal in real estate, other than real estate limited
partnerships, and may purchase and sell marketable securities which are secured
by interests in real estate;
(3) make loans except: (i) by purchasing debt securities in accordance with its
investment objectives and policies, or entering into repurchase agreements,
subject to the limitations described in non-fundamental limitation (7), below,
(ii) by lending its portfolio securities, and (iii) by lending portfolio assets
to other portfolios of the Fund, so long as such loans are not inconsistent with
the 1940 Act, or the rules and regulations, or interpretations or orders of the
SEC thereunder;
(4) with respect to 75% of its assets, purchase a security if, as a result, it
would hold more than 10% (taken at the time of such investment) of the
outstanding voting securities of any issuer (this restriction is not applicable
to the Global Fixed Income, International Fixed Income, Advisory Foreign Fixed
Income or the Emerging Markets Value Portfolios);
(5) with respect to 75% of its assets, purchase securities of any issuer if, as
a result, more than 5% of the portfolio's total assets, taken at market value at
the time of such investment, would be invested in the securities of such issuer
except that this restriction does not apply to securities issued or guaranteed
by the U.S. Government or its agencies or instrumentalities (this restriction
does not apply to the Global Fixed Income, International Fixed Income, Advisory
Foreign Fixed Income or the Emerging Markets Value Portfolios);
(6) borrow money, except (i) as a temporary measure for extraordinary or
emergency purposes, and (ii) in connection with reverse repurchase agreements,
provided that (i) and (ii) in combination do not exceed 33 1/3% of the
portfolio's total assets (including the amount borrowed) less liabilities
(exclusive of borrowings);
(7) underwrite the securities of other issuers (except to the extent that the
fund may be deemed to be an underwriter within the meaning of the Securities Act
of 1933 in connection with the disposition of restricted securities); and
(8) acquire any securities of companies within one industry, if, as a result of
such acquisition, more than 25% of the value of the portfolio's total assets
would be invested in securities of companies within such industry; provided,
however that (i) there shall be no limitation on the purchase of obligations
issued or guaranteed by the U.S. Government, its agencies or instrumentalities;
(ii) the Cash Reserves Portfolio may invest without limitation in certificates
of deposit or bankers' acceptances of domestic banks; (iii) utility companies
will be divided according to their services, for example, gas, gas transmission,
electric and telephone will each be considered a separate industry; (iv)
financial service companies will be classified according to the end users of
their services, for example, automobile finance, bank finance and diversified
finance will each be considered a separate industry; (v) asset-backed securities
will be classified according to the underlying assets securing such securities;
and (vi) the Mortgage-Backed Securities and Advisory Mortgage Portfolios will
concentrate in mortgage-backed securities.
24
Each portfolio is also subject to the following restrictions which may be
changed by the Board of Trustees without shareholder approval.
As a matter of non-fundamental policy, no portfolio will:
(1) enter into futures contracts to the extent that each portfolio's outstanding
obligations to purchase securities under these contracts in combination with its
outstanding obligations with respect to options transactions would exceed 50% of
each portfolio's total assets, and will maintain assets sufficient to meet its
obligations under such contracts in a segregated account with the custodian bank
or will otherwise comply with the SEC's position on asset coverage;
(2) write put or call options except to the extent described above in (1);
(3) purchase on margin, except for use of short-term credit as may be necessary
for the clearance of purchases and sales of securities, provided that each
portfolio may make margin deposits in connection with transactions in options,
futures, and options on futures;
(4) sell short unless, the portfolio (i) by virtue of its ownership of other
securities, has the right to obtain securities equivalent in kind and amount to
the securities sold and, if the right is conditional, the sale is made upon the
same conditions, or (ii) maintains in a segregated account on the books of the
Fund's custodian an amount that, when combined with the amount of collateral
deposited with the broker in connection with the short sale, equals the current
market value of the security sold short or such other amount as the SEC or its
staff may permit by rule, regulation, order or interpretation (transactions in
futures contracts and options, however, are not deemed to constitute selling
securities short);
(5) borrow money other than from banks or other portfolios of MAS Funds,
provided that a portfolio may borrow from banks or other portfolios of MAS Funds
so long as such borrowing is not inconsistent with the 1940 Act or the rules,
regulations, interpretations or orders of the SEC and its staff thereunder; or
purchase additional securities when borrowings exceed 5% of total (gross)
assets;
(6) pledge, mortgage or hypothecate assets in an amount greater than 50% of its
total assets, provided that each portfolio may segregate assets without limit in
order to comply with the requirements of Section 18(f) of the 1940 Act and
applicable rules, regulations or interpretations of the SEC and its staff;
(7) invest more than an aggregate of 15% of the net assets of the portfolio,
determined at the time of investment, in illiquid securities provided that this
limitation shall not apply to any investment in securities that are not
registered under the 1933 Act but that can be sold to qualified institutional
investors in accordance with Rule 144A under the 1933 Act and are determined to
be liquid securities under guidelines or procedures adopted by the Board of
Trustees;
(8) invest for the purpose of exercising control over management of any company;
and
(9) invest its assets in securities of any investment company, except as
permitted by the 1940 Act or the rules, regulations, interpretations or orders
of the SEC and its staff thereunder.
Unless otherwise indicated, if a percentage limitation on investment or
utilization of assets as set forth above is adhered to at the time an investment
is made, a later change in percentage resulting from changes in the value or
total cost of the portfolio's assets will not be considered a violation of the
restriction, and the sale of securities will not be required.
25
MANAGEMENT OF THE FUND
Trustees and Officers
The Fund's officers, under the supervision of the Board of Trustees, manage the
day-to-day operations of the Fund. The Trustees set broad policies for the Fund
and choose its officers. The following is a list of the Trustees and officers of
the Fund and a brief statement of their present positions and principal
occupations during the past 5 years:
Thomas L. Bennett,* Chairman of the Board of Trustees; Managing Director, Morgan
Stanley; Portfolio Manager and member of the Executive Committee, Miller
Anderson & Sherrerd, LLP; Director, MAS Fund Distribution, Inc.; formerly
Director, Morgan Stanley Universal Funds, Inc.
Thomas P. Gerrity, Trustee; Dean and Reliance Professor of Management and
Private Enterprise, Wharton School of Business , University of Pennsylvania;
Director, Digital Equipment Corp.; Director, Sun Company, Inc.; Director, Fannie
Mae; Director, Reliance Group Holdings; Director, CVS Corporation; Director,
Union Carbide Corporation.
Joseph P. Healey, Trustee; Headmaster, Haverford School; formerly Dean, Hobart
College; Associate Dean, William & Mary College.
Joseph J. Kearns, Trustee; Vice President and Treasurer, The J. Paul Getty
Trust; Director, Electro Rent Corporation; Trustee, Southern California Edison
Nuclear Decommissioning Trust; Director, The Ford Family Foundation.
Vincent R. McLean, Trustee; Director, Legal and General America, Inc.; Director,
William Penn Life Insurance Company of New York; formerly Executive Vice
President, Chief Financial Officer, Director and Member of the Executive
Committee of Sperry Corporation (now part of Unisys Corporation).
C. Oscar Morong, Jr., Trustee; Managing Director, Morong Capital Management;
Director, Ministers and Missionaries Benefit Board of American Baptist Churches,
The Indonesia Fund, The Landmark Funds; formerly Senior Vice President and
Investment Manager for CREF, TIAA-CREF Investment Management, Inc.
*Trustee Bennett is deemed to be an "interested person" of the Fund as that term
is defined in the 1940 Act.
- ------------------------------------------------------------------------------
James D. Schmid, President, MAS Funds; Principal, Morgan Stanley; Head of Mutual
Funds, Miller Anderson & Sherrerd, LLP; Director, MAS Fund Distribution, Inc.,
Chairman of the Board of Directors, The Minerva Fund, Inc.; formerly Vice
President, The Chase Manhattan Bank.
Lorraine Truten, CFA, Vice President, MAS Funds; Principal, Morgan Stanley; Head
of Mutual Fund Services, Miller Anderson & Sherrerd, LLP; President, MAS Fund
Distribution, Inc.
John H. Grady, Jr., Secretary, MAS Funds; Partner, Morgan, Lewis & Bockius LLP;
formerly Attorney, Ropes & Gray.
26
Remuneration of Trustees and Officers
The Fund pays each Trustee, who is not also an officer or interested person, a
fee for each Board of Trustees Meeting attended plus travel and other expenses
incurred in attending such meetings. Trustees who are also officers or
interested persons receive no remuneration for their service as Trustees. The
Fund's officers and employees are paid by the Adviser or Sub-Administrator.
The Fund maintains an unfunded Deferred Compensation Plan ("Plan") which allows
each independent Trustee to defer payment of his or her retainer and fees to a
later date. The Fund's policy is for each Trustee to defer at least twenty-five
percent (25%) of his or her retainer and fees received annually from the Fund.
To that end, the Plan requires that each Eligible Trustee (defined by the Plan
as a member of the Board of Trustees who is not an "interested person" of the
Fund, as such term is defined under Section 2(a)(19) of the 1940 Act) defer his
or her entire retainer, which is deemed a deferral of twenty-five percent (25%)
of the Trustee's retainer and fees received from the Fund for the year. The Plan
also permits the Eligible Trustee to defer all, or a portion, of the fees
received for attending meetings of the Board of Trustees throughout the year.
Amounts deferred by each Eligible Trustee are credited with a return equal to
what those amounts would have received if they had been invested in portfolios
of the Fund selected by that Trustee. Any deferred amounts will not be available
to Eligible Trustees for a period of three (3) or more years and distributions
may not be deferred beyond the Eligible Trustee's membership on the Board of
Trustees. Distributions to an Eligible Trustee are either in the form of a lump
sum or equal annual installments over a period of five (5) years and commence
within ninety (90) days after the last date during the deferral period on which
the Fund makes a valuation of the Eligible Trustee's deferred compensation. The
Fund intends that the Plan shall be maintained at all times on an unfunded basis
for federal income tax purposes under the Internal Revenue Code of 1986. The
rights of an Eligible Trustee and the beneficiaries to the amounts held under
the Plan are unsecured and such amounts are subject to the claims of the
creditors of the Fund. The Plan became effective May 23, 1996. There were no
payments under the Plan during the fiscal year ended September 30, 1997.
As of the fiscal year ended September 30, 1997, the Trustees and officers of the
Fund owned, in the aggregate, less than 1% of the outstanding shares of the
Fund. The aggregate compensation paid by the Fund to each of the Trustees during
its fiscal year ended September 30, 1997 is set forth below.
Aggregate Pension or Benefits
Compensation from Accrued as Part of Total Compensation
Name of Trustee the Fund# Fund Expenses from the Fund
- --------------- --------- ------------- -------------
Thomas L. Bennett* -0- -0- -0-
Thomas P. Gerrity $57,000## $64,942 $57,000
Joseph P. Healey $57,000## $30,173 $57,000
Joseph J. Kearns $57,000## $60,102 $57,000
C. Oscar Morong, Jr. $57,000## $89,534 $57,000
Vincent R. McLean $57,000## $96,238 $57,000
27
* Trustee Bennett is deemed to be an "interested person" of the Fund as that
term is defined in the 1940 Act.
# Includes amounts deferred from quarterly meeting fees at the election of
Trustees under the Deferred Compensation Plan.
## In addition, each Trustee has deferred his retainer of $12,000 under the
Deferred Compensation Plan.
Principal Holders of Securities
As of January 5, 1998 the following persons owned of record or beneficially 5%
or more of the shares of a portfolio:
Equity Portfolio: Los Angeles County Deferred Compensation & Thrift Plan,
Englewood, CO, 7.4%.
Value Portfolio: Charles Schwab & Co., Inc., Special Custody Account for the
Exclusive Benefit of Customers, San Francisco, CA, 13.7%; Donaldson Lufkin &
Jenrette, Jersey City, NJ, 6.0%.
Small Cap Value Portfolio: The J. Paul Getty Trust, c/o The Northern Trust
Company, Chicago, IL, 10.6%; The Northern Trust Company, FBO Silicon Graphics,
Chicago, IL, 9.5%; Fishnet & Company, FBO The Hearst Foundation, Boston, MA,
5.1%.
Mid Cap Growth Portfolio: The J. Paul Getty Trust, c/o The Northern Trust
Company, Chicago, IL, 23.5%; Morgan Stanley, c/o MAS Team, Boston, MA, 6.2%; MAC
& Co., Pittsburgh, PA, 5.4%.
Domestic Fixed Income Portfolio: Fleet National Bank, Rochester, NY, 11.7%; The
Philadelphia Orchestra Unrestricted Endowment Fund, Philadelphia, PA, 11.0%;
Saxon & Company, FBO Weirton Medical Center Retirement Income Plan,
Philadelphia, PA, 9.2%; Strafe & Co., Marion General Hospital Retirement Plan,
Westerville, OH, 9.0%; Paintmakers Money Accumulation Pension Plan-B, Portland,
OR, 8.6%; Patterson & Co., c/o CoreStates Bank, N.A., Philadelphia, PA, 6.8%;
Key Trust Danis Industries, Cleveland, OH, 6.2%; Delta Dental Plan of NH, Inc.,
Concord, NH, 5.9%.
Cash Reserves Portfolio: The Northern Trust Company, Chicago, IL, 32.3%; The
Taft School, Watertown, CT, 13.1%; Skadden ARPS Slate Meagher & Flom LLP, New
York, NY, 11.2%; Association for Information and Image Management, Silver
Spring, MD, 5.2%.
International Equity Portfolio: Western Metal Industry, c/o Miller Andersen &
Sherrerd, West Conshohocken, PA, 11.8%; Ministers & Missionaries Benefit Board
of American Baptist Churches, New York, NY, 11.0%; Carnegie Corporation of New
York, New York, NY, 6.8%; Puerto Rico Telephone Company Pension Plan, San Juan,
PR, 6.3%.
Fixed Income Portfolio II: Diocese of Camden, Camden, NJ, 10.4%; Bankers Trust
Co., Jersey City, NJ, 9.9%; Board of Trustees of Sheet Metal Workers Local #100
Pension Plan, Suitland, MD, 9.5%; The Northern Trust Company, Chicago, IL, 6.5%;
Saul & Co., c/o First Union National Bank, Charlotte, NC, 6.2%.
High Yield Securities Portfolio: Charles Schwab & Co., Inc., Special Custody
Account for the Exclusive Benefit of Customers, San Francisco, CA, 8.5%; Western
Metal Industry, c/o Miller Andersen & Sherrerd, West Conshohocken, PA, 7.0%;
Donaldson Lufkin & Jenrette, Jersey City, NJ, 6.2%; Armco Master Pension Trust,
Pittsburgh, PA, 5.3%.
28
Special Purpose Fixed Income Portfolio: Robertson Research Fund, Cold Spring
Harbor, NY, 5.2%.
Limited Duration Portfolio: Bankers Trust Company, Los Angeles, CA, 14.4%; Boys
& Girls Club of America Pension Trust, Atlanta, GA, 11.9%; Citibank, NA,
Fieldcrest Cannon Hourly Retirement Plan, Tampa, FL, 8.6%; Northern California
Bakery Drivers Security Fund, Alameda, CA 7.0%; Batrus & Co., c/o Bankers Trust
Company, New York, NY, 6.4%; Sheet Metal Workers Local # 100, Washington, DC,
5.8%.
Mortgage-Backed Securities Portfolio: Northwestern University Investment
Department, Evanston, IL, 30.6%; John S. Donovan, Trustee for Cives Corporation
Savings and Profit-Sharing Retirement Trust, Roswell, GA, 25.3%; The Paper Magic
Group, Inc., Scranton, PA, 16.3%; Melhorn & Co., c/o PNC Bank 641 Teamster
Pension, Philadelphia, PA 16.3%.
International Fixed Income Portfolio: Armco Master Pension Trust, Pittsburgh,
PA, 16.4%; CoreStates Bank, Childrens Hospital, Philadelphia, PA, 15.5%;
Northern Trust Co. as Custodian FBO: The J. Paul Getty Trust, Chicago, IL,
12.7%; The Skillman Foundation, Detroit, MI, 11.4%; Western Metal Industry
Pension Fund, c/o Miller Anderson & Sherrerd, West Conshohocken, PA, 9.6%;
Syntex (U.S.A.) Inc., Pension Trust, Palo Alto, CA, 6.7%; Chemical Bank as
Custodian for Smithsonian Institution, New York, NY, 6.1%; Wellesley College,
Wellesley, MA, 5.4%.
Emerging Markets Value Portfolio: Ministers & Missionaries Benefit Board of the
American Baptist Churches, New York, NY, 34.9%; Chemical Bank as Custodian for
Smithsonian Institution, New York, NY, 33.0%; Richard B. Worley, c/o Miller
Anderson & Sherrerd, West Conshohocken, PA, 7.7%; Philadelphia Orchestra
Association, Employee Pension & Retirement Plan, Philadelphia, PA 6.0%.
PA Municipal Portfolio: Kenneth B. Dunn & Pamela R. Dunn, Bala Cynwyd, PA 20.7%;
R. & S. Roberts, Philadelphia, PA, 17.9%; Southwest National Bank of PA,
Greensburg, PA 11.7%; John J. F. Sherrerd, Bryn Mawr, PA, 9.3%; A. Morris
Williams, Jr. & Ruth W. Williams, Gladwyne, PA, 6.9%; Sanford C. Bernstein & Co.
Inc., FBO Cook Family Fund, New York, NY, 5.2%.
Municipal Portfolio: Bost &Co., FBO Union Electric Employees Benefit Trust for
Union Retirees, Pittsburgh, PA, 21.2%; Bost & Co., FBO Union Electric Employee
Benefit Trust for Management Retirees, Pittsburgh, PA, 12.2%; Batrus & Co., c/o
Bankers Trust Company, New York, NY, 8.6%; Robert A. Fox, Jenkintown, PA, 8.4%;
Jesse J. Thompson, Charlotte, NC, 8.4%.
Balanced Portfolio: Northern Trust Co., Chicago, IL, 30.2%; Wendel & Co.,
Trustee for A&P Savings Plan, New York, NY, 8.7%; Wendel & Co., c/o The Bank of
New York, New York, NY, 7.3%; Wendel & Co.,c/o The Bank of New York, New York,
NY, 6.7%; Wendel & Co., FAO Aramark Corporation, New York, NY, 5.9%; Fidelity
Investments Institutional Operations Co., Covington, KY, 6.5%.
Global Fixed Income Portfolio: The Charles A. Dana Foundation, Inc., New York,
NY, 31.1%; "All for Her" Fund, c/o Rosary Inc., Albany, NY, 13.9%; Hudson-Webber
Foundation, Detroit, MI, 13.0%; Abilene Christian University, Abilene, TX,
10.2%; State Street Bank & Trust, Forest Oil Corporation Pension Trust, Boston,
MA, 8.4%; Rockefeller Family Fund Inc., New York, NY, 5.8%.
Intermediate Duration Portfolio: Southwest National Bank of PA, Greensburg, PA,
30.8%; Bankers Trust Company, the Los Angeles Hotel-Restaurant Employer Union
Welfare Fund, Los Angeles, CA, 19.2%; Jaffe Foundation, Suffern, NY, 11.5%;
Northumberland County Employees Retirement Fund, Altoona, PA, 8.1%; Nyack
Hospital, Nyack, NY, 6.5%.
29
Multi-Asset-Class-Portfolio: Albany Medical College, Albany, NY, 17.8%; Chase
Manhattan Bank, Milbank Tweed Hadley & McCloy Master trust, Brooklyn, NY, 11.5%;
The Library Company of Philadelphia, Philadelphia, PA, 8.7%; Wachovia Bank, NA,
The W-S Foundation, Winston-Salem, NC, 5.3%; The National Center for State
Courts, Williamsburg, VA, 5.2%.
Advisory Foreign Fixed Income Portfolio: Minnesota State Board of Investments,
St. Paul, MN, 8.4%; Ford Motor Company Master Trust, Dearborn, MI, 7.0%; Kaiser
Foundation, Oakland, CA, 6.0%.
Mid Cap Value Portfolio: Charles Schwab & Co., Inc., Special Custody Account for
the Exclusive Benefit of Customers, San Francisco, CA, 10.7%; Georgetown
Memorial Hospital Funded Depreciation Account, Georgetown, SC, 9.3%; Fishnet &
Co., Boston, MA, 7.8%; The Chase Manhattan Bank, FAO Hearst Corporation, New
York, NY, 7.8%; Berklee College of Music, Boston, MA, 7.0%; The Northern Trust
Company, FBO Morgan Stanley Plan, Chicago, IL, 5.3%.
Advisory Mortgage Portfolio: Ford Motor Company Master Trust, Dearborn, MI,
9.8%; Public School Teachers of Chicago, Chicago, IL, 5.1%.
Multi-Market Fixed Income Portfolio: Connelly Foundation, West Conshohocken, PA,
73.4%; The Greenwall Foundation, New York, NY, 18.0%; Paperworkers Union Local
#286, Philadelphia, PA, 5.1%.
The persons listed above as owning 25% or more of the outstanding shares of each
portfolio may be presumed to "control" (as that term is defined in the 1940 Act)
such portfolios. As a result, those persons would have the ability to vote a
majority of the shares of the portfolios on any matter requiring the approval of
shareholders of such portfolios.
DISTRIBUTION PLANS
The Fund's Distribution Plan provides that the Adviser Class Shares will pay MAS
Fund Distribution, Inc. (the "Distributor") an annualized fee of .25% of the
average daily net assets of each portfolio attributable to Adviser Class Shares,
which the Distributor can use to compensate broker/dealers and service providers
which provide distribution services to Adviser Class Shareholders or their
customers who beneficially own Adviser Class Shares.
The Fund has adopted the Distribution Plan in accordance with the provisions of
Rule 12b-1 under the 1940 Act which regulates circumstances under which an
investment company may directly or indirectly bear expenses relating to the
distribution of its shares. Continuance of the Plan must be approved annually by
a majority of the Trustees of the Fund and the Trustees who are not "interested
persons" of the Fund within the meaning of the 1940 Act. The Plan requires that
quarterly written reports of amounts spent under the Plan and the purposes of
such expenditures be furnished to and reviewed by the Trustees. The Plan may not
be amended to increase materially the amount which may be spent thereunder
without approval by a majority of the outstanding Adviser Class Shares of the
Fund. All material amendments of the Plan will require approval by a majority of
the Trustees of the Fund and of the Trustees who are not "interested persons" of
the Fund. For the fiscal year ended September 30, 1997, the Mid Cap Growth,
Value, Fixed Income, High Yield and Balanced Portfolios paid $665, $201,647,
$67,500, $3,009 and $37,084, respectively, in distribution fees pursuant to the
Distribution Plan. Other than $4,492 of fees retained by the Distributor, fees
paid to the Distributor during the fiscal year were used to reimburse
third-parties for distribution-related services performed on behalf of the Fund.
30
SHAREHOLDER SERVICE AGREEMENT
The Fund has entered into a Shareholder Service Agreement with the Distributor
whereby the Distributor will compensate service providers who provide certain
services to clients who beneficially own Investment Class shares of the
portfolios described in the Investment Class prospectus. Each portfolio will pay
to the Distributor a fee at the annual rate of .15% of the average daily net
assets of such portfolio attributable to the shares serviced by the service
provider, which fee will be computed daily and paid monthly. During the fiscal
year ended September 30, 1997, the Fund paid $61, 244 to compensate the
Distributor under this Shareholder Service Agreement.
INVESTMENT ADVISER
Under an Investment Advisory Agreement ("Agreement") with the Fund, the Adviser,
subject to the control and supervision of the Fund's Board of Trustees and in
conformance with the stated investment objectives and policies of each portfolio
of the Fund, manages the investment and reinvestment of the assets of each
portfolio of the Fund. In this regard, it is the responsibility of the Adviser
to make investment decisions for the Fund's portfolios and to place each
portfolio's purchase and sales orders for investment securities.
As compensation for the services rendered by the Adviser under the Agreement and
the assumption by the Adviser of the expenses related thereto (other than the
cost of securities purchased for the portfolios and the taxes and brokerage
commissions, if any, payable in connection with the purchase and/or sale of such
securities), each portfolio pays the Adviser an advisory fee calculated by
applying a quarterly rate, based on the following annual percentage rates, to
the portfolio's average daily net assets for the quarter:
Rate
----
Emerging Markets Value Portfolio 0.750%
Equity Portfolio 0.500
Growth Portfolio 0.500
International Equity Portfolio 0.500
Mid Cap Growth Portfolio 0.500
Mid Cap Value Portfolio 0.750
Small Cap Value Portfolio 0.750
Value Portfolio 0.500
Cash Reserves Portfolio 0.250
Domestic Fixed Income Portfolio 0.375
Fixed Income Portfolio 0.375
Fixed Income II Portfolio 0.375
Global Fixed Income Portfolio 0.375
Multi-Market Fixed Income Portfolio 0.450
High Yield Portfolio 0.375
Intermediate Duration Portfolio 0.375
International Fixed Income Portfolio 0.375
Limited Duration Portfolio 0.300
Mortgage-Backed Securities Portfolio 0.375
Municipal Portfolio 0.375
PA Municipal Portfolio 0.375
Special Purpose Fixed Income Portfolio 0.375
Balanced Portfolio 0.450
31
Multi-Asset-Class Portfolio 0.650
Balanced Plus Portfolio 0.550
Advisory Foreign Fixed Income Portfolio 0.375
Advisory Mortgage Portfolio 0.375
In cases where a shareholder of any of the portfolios has an investment
counseling relationship with the Adviser, the Adviser may, at its discretion,
reduce the shareholder's investment counseling fees by an amount equal to the
pro-rata advisory fees paid by the Fund. This procedure will be utilized with
clients having contractual relationships based on total assets managed by Miller
Anderson & Sherrerd, LLP to avoid situations where excess advisory fees might be
paid to the Adviser. In no event will a client pay higher total advisory fees as
a result of the client's investment in the Fund. In addition, the Adviser has
voluntarily agreed to waive its advisory fees and/or reimburse certain expenses
to the extent necessary, if any, to keep total annual operating expenses
actually deducted from portfolio assets for the Institutional Class of the
Emerging Markets Value, Cash Reserves, Mortgage-Backed Securities, Municipal, PA
Municipal, Multi-Market Fixed Income, Advisory Foreign Fixed Income and Advisory
Mortgage Portfolios from exceeding 1.180%, .320%, .500%, .500%, .500%, .580%,
.150% and .080% of its average daily net assets, respectively. With respect to
the Investment Class and the Adviser Class of the Multi-Asset-Class Portfolio,
the Adviser is, on a voluntary basis, waiving its fees and/or reimbursing
certain expenses. The fee waivers and expense reimbursements for the Investment
Class and Adviser Class of the Multi-Asset-Class Portfolio are voluntary and
may be discontinues at any time at the Adviser's discretion. With respect to the
Institutional Class of the Multi-Asset-Class Portfolio, the Adviser has
voluntarily agreed to waive its advisory fees and/or reimburse certain expenses
to keep total operating expenses from exceeding 0.780%.
For the fiscal years ended September 30, 1995, 1996 and 1997, the Fund paid the
following advisory fees:
Advisory Fees Paid Advisory Fees Waived
1995 1996 1997 1995 1996 1997
Portfolio (000) (000) (000) (000) (000) (000)
- --------- ----- ----- ----- ----- ----- -----
Emerging Markets Value Portfolio $ 85 $ 286 $ 195 $ 52 $ 42 $ 30
Equity Portfolio 6,840 7,785 6,928 0 0 0
Growth Portfolio * * * * * *
International Equity Portfolio 5,437 3,458 3,236 0 0 0
Mid Cap Growth Portfolio 1,504 1,986 1,961 0 0 0
Mid Cap Value Portfolio 0 188 896 14 46 28
Small Cap Value Portfolio 2,683 3,464 5,161 0 0 0
Value Portfolio 5,078 7,716 14,010 0 0 0
Cash Reserves Portfolio 51 138 166 39 52 65
Domestic Fixed Income Portfolio 75 257 372 23 8 11
Fixed Income Portfolio 4,893 5,917 9,431 0 0 0
Fixed Income II Portfolio 567 773 776 0 0 0
Global Fixed Income Portfolio 190 205 289 0 0 0
Multi-Market Fixed Income Portfolio * * * * * *
High Yield Portfolio 764 1,073 1,558 0 0 0
Intermediate Duration Portfolio 57 52 144 17 18 23
International Fixed Income Portfolio 395 555 549 0 0 0
Limited Duration Portfolio 206 351 404 11 0 4
32
Mortgage-Backed Securities Portfolio 348 177 173 5 21 22
Municipal Portfolio 110 167 211 37 38 30
PA Municipal Portfolio 32 77 79 31 30 26
Special Purpose Fixed Income Portfolio 1,574 1,517 1,816 0 0 0
Balanced Portfolio 1,385 1,521 1,527 0 0 0
Multi-Asset-Class Portfolio 220 635 797 100 112 126
Balanced Plus Portfolio * * * * * *
Advisory Foreign Fixed Income Portfolio 0 1,933 0 1,631 1,933 713
Advisory Mortgage Portfolio 0 6,056 0 1,711 6,056 9,155
* Not in operation during the period.
The Agreement continues for successive one year periods, only if each renewal is
specifically approved by a vote of the Fund's Board of Trustees, including the
affirmative votes of a majority of the Trustees who are not parties to the
agreement or "interested persons" (as defined in the 1940 Act) of any such party
in person at a meeting called for the purpose of considering such approval. In
addition, the question of continuance of the Agreement may be presented to the
shareholders of the Fund; in such event, continuance shall be effected only if
approved by the affirmative vote of a majority of the outstanding voting
securities of each portfolio of the Fund. If the holders of any portfolio fail
to approve the Agreement, the Adviser may continue to serve as investment
adviser to each portfolio which approved the Agreement, and to any portfolio
which did not approve the Agreement until new arrangements have been made. The
Agreement is automatically terminated if assigned, and may be terminated by any
portfolio without penalty, at any time, (1) by vote of the Board of Trustees or
by vote of the outstanding voting securities of the portfolio or (2) on sixty
(60) days' written notice to the Adviser, or (3) by the Adviser upon ninety (90)
days' written notice to the Fund.
The Fund bears all of its own costs and expenses, including but not limited to:
services of its independent accountants, its administrator and dividend
disbursing and transfer agent, legal counsel, taxes, insurance premiums, costs
incidental to meetings of its shareholders and Trustees, the cost of filing its
registration statements under federal and state securities laws, reports to
shareholders, and custodian fees. These Fund expenses are, in turn, allocated to
each portfolio, based on their relative net assets. Each portfolio bears its own
advisory fees and brokerage commissions and transfer taxes in connection with
the acquisition and disposition of its investment securities.
ADMINISTRATION
MAS also serves as Administrator to the Fund pursuant to an Administration
Agreement dated as of November 18, 1993. Chase Global Funds Services Company
(formerly Mutual Fund Services Company, or MFSC), an affiliate of The Chase
Manhattan Bank, serves as transfer agent and provides fund accounting and other
services pursuant to a sub-administration agreement.
For the fiscal years ended September 30, 1995, 1996 and 1997, the Fund paid the
following administrative fees:
Administrative Fees Paid
1995 1996 1997
(000) (000) (000)
--------------------------------
Emerging Markets Value Portfolio $ 14 $ 38 $ 24
Equity Portfolio 1,094 1,246 1,136
Growth Portfolio * * *
International Equity Portfolio 870 553 544
33
Mid Cap Growth Portfolio 241 318 314
Mid Cap Value Portfolio 1 20 123
Small Cap Value Portfolio 286 369 550
Value Portfolio 812 1,235 2,285
Cash Reserves Portfolio 29 44 74
Domestic Fixed Income Portfolio 21 55 82
Fixed Income Portfolio 1,044 1,262 2,030
Fixed Income II Portfolio 121 165 165
Global Fixed Income Portfolio 41 44 62
Multi-Market Fixed Income Portfolio * * *
High Yield Portfolio 163 229 356
Intermediate Duration Portfolio 16 11 36
International Fixed Income Portfolio 84 118 117
Limited Duration Portfolio 58 93 109
Mortgage-Backed Securities Portfolio 75 38 42
Municipal Portfolio 31 36 51
PA Municipal Portfolio 13 16 22
Special Purpose Fixed Income Portfolio 336 323 414
Balanced Portfolio 246 271 280
Multi-Asset-Class Portfolio 57 113 143
Balanced Plus Portfolio * * *
Advisory Foreign Fixed Income Portfolio 357 412 152
Advisory Mortgage Portfolio 374 1,292 1,954
* Not in operation during the period.
DISTRIBUTOR FOR FUND
MAS Fund Distribution, Inc. (the "Distributor"), a wholly-owned subsidiary of
the Adviser, with its principal office at One Tower Bridge, West Conshohocken,
Pennsylvania 19428, distributes the shares of the Fund. Under the Distribution
Agreement, the Distributor, as agent of the Fund, agrees to use its best efforts
as sole distributor of the Fund's shares. The Distribution Agreement continues
in effect so long as such continuance is approved at least annually by the
Fund's Board of Trustees, including a majority of those Trustees who are not
parties to such Distribution Agreement nor interested persons of any such party.
The Distribution Agreement provides that the Fund will bear the costs of the
registration of its shares with the SEC and various states and the printing of
its prospectuses, statements of additional information and reports to
shareholders.
CUSTODIANS
The Chase Manhattan Bank, New York, NY and Morgan Stanley Trust Company (NY),
Brooklyn, NY serve as custodians for the Fund. The Custodians hold cash,
securities, and other assets of the Fund as required by the 1940 Act. Morgan
Stanley Trust Company is an affiliated person, as defined in the 1940 Act, of
the Adviser and is compensated for its services as custodian on a per account
basis plus out of pocket expenses.
PORTFOLIO TRANSACTIONS
The Investment Advisory Agreement authorizes the Adviser to select the brokers
or dealers that will execute the purchases and sales of investment securities
for each of the Fund's portfolios and directs the Adviser to use its best
efforts to obtain the best execution with respect to all transactions for the
portfolios. In so doing, the Adviser will consider all matters it deems
relevant, including the following: the Adviser's knowledge of negotiated
commission rates and spreads currently available; the nature of the security or
instrument being traded; the size and type of the transaction; the nature and
character of the markets for the security or instrument to be purchased or sold;
the desired timing of the transaction; the activity existing and expected in the
market for the particular security or
34
instrument; confidentiality; the execution, clearance, and settlement
capabilities of the broker or dealer selected and other brokers or dealers
considered; the reputation and perceived soundness of the broker or dealer
selected and other brokers or dealers considered; the Adviser's knowledge of any
actual or apparent operational problems of a broker or dealer; and the
reasonableness of the commission or its equivalent for the specific transaction.
Although the Adviser generally seeks competitive commission rates and dealer
spreads, a portfolio will not necessarily pay the lowest available commission on
brokerage transactions or markups on principal transactions. Transactions may
involve specialized services on the part of the broker or dealer involved, and
thereby justify higher commissions or markups than would be the case with other
transactions requiring more routine services. In addition, a portfolio may pay
higher commission rates or markups than the lowest available when the Adviser
believes it is reasonable to do so in light of the value of the research,
statistical, pricing, and execution services provided by the broker or dealer
effecting the transaction. The Adviser does not attempt to put a specific dollar
value on the research services rendered or to allocate the relative costs or
benefits of those services among its clients, believing that the research it
receives will help the Adviser to fulfill its overall duty to its clients. The
Adviser uses research services obtained in this manner for the benefit of all of
its clients, though each particular research service may not be used to service
each client. As a result, the Fund may pay brokerage commissions or markups that
are used, in part, to purchase research services that are not used to benefit
the Fund.
It is not the Fund's practice to allocate brokerage or principal business on the
basis of sales of shares which may be made through intermediary brokers or
dealers. However, the Adviser may place portfolio orders with qualified
broker-dealers who recommend the Fund's portfolios or who act as agents in the
purchase of shares of the portfolios for their clients. During the fiscal years
ended September 30, 1995, 1996 and 1997, the Fund paid brokerage commissions of
$13,457,075, $18,252,335 and $19,134,219, respectively.
Some securities considered for investment by each of the Fund's portfolios may
also be appropriate for other clients serviced by the Adviser. The Adviser may
place a combined order for two or more accounts or portfolios for the purchase
or sale of the same security if, in its judgment, joint execution is in the best
interest of each participant and will result in best price execution.
Transactions involving commingled orders are allocated in a manner deemed to be
equitable to each account or portfolio. Although it is recognized that, in some
cases, joint execution of orders could adversely affect the price or volume of
the security that a particular account or fund may obtain, it is the opinion of
the Adviser and the Fund's Board of Trustees that combining such orders
generally will be more advantageous to the Fund than effecting such transactions
separately.
If purchases or sales of securities consistent with the investment policies of a
portfolio and one or more of these other clients serviced by the Adviser is
considered at or about the same time, transactions in such securities will be
allocated among the portfolio and clients in a manner deemed fair and reasonable
by the Adviser. Although there is no specified formula for allocating such
transactions, the various allocation methods used by the Adviser, and the
results of such allocations, are subject to periodic review by the Fund's
Trustees.
On May 31, 1997, Morgan Stanley Group Inc., then the indirect parent of the
Adviser, merged with Dean Witter, Discover & Co. to form Morgan Stanley, Dean
Witter, Discover & Co. As an indirect subsidiary of Morgan Stanley, Dean Witter,
Discover & Co., the Adviser is affiliated with certain U.S.-registered
broker-dealers and foreign broker-dealers (collectively, the AAffiliated
Brokers@). The Adviser may, in the exercise of its discretion under its
investment management agreement, effect transactions in securities or other
instruments for the Fund through the Affiliated Brokers. The Fund paid $132,104
in brokerage commissions to affiliates for $75,128,827 of brokered transactions
for the fiscal year ended September 30, 1997.
35
ANNUAL TURNOVER
The annual turnover rate for each portfolio for the past two fiscal years ended
September 30 was as follows:
Portfolio 1996 1997
- --------- ---- ----
Emerging Markets Value 108% 64%
Equity 67% 85%
Growth N/A N/A
International Equity 78% 62%
Mid Cap Growth 141% 134%
Mid Cap Value 377% 184%
Small Cap Value 145% 107%
Value 53% 46%
Domestic Fixed Income 168% 217%
Fixed Income 162% 179%
Fixed Income II 165% 182%
Global Fixed Income 133% 137%
Multi-Market Fixed Income N/A N/A
High Yield 115% 96%
Intermediate Duration 251% 204%
International Fixed Income 124% 107%
Limited Duration 174% 130%
Mortgage-Backed Securities 116% 164%
Municipal 78% 54%
PA Municipal 51% 64%
Special Purpose Fixed Income 151% 198%
Balanced 110% 145%
Multi-Asset-Class 122% 141%
Balanced Plus N/A N/A
Advisory Mortgage 139% 144%
Advisory Foreign Fixed Income 170% 208%
N/A -- Portfolio had not commenced operations as of September 30, 1997.
GENERAL INFORMATION
Description of Shares and Voting Rights
The Declaration of Trust permits the Trustees to issue an unlimited number of
shares of beneficial interest, without par value, from an unlimited number of
series ("portfolios") of shares. Currently the Fund is offering shares of
twenty-seven portfolios.
The shares of each portfolio of the Fund are fully paid and non-assessable,
except as set forth below, and have no preference as to conversion, exchange,
dividends, retirement or other features. The shares of each portfolio of the
Fund have no preemptive rights. The shares of the Fund have non-cumulative
voting rights, which means that the holders of more than 50% of the shares
voting for the election of Trustees can elect 100% of the Trustees if they
choose to do so. A shareholder of a class is entitled to one vote for each full
class share held (and a fractional vote for each fractional class share held) in
the shareholder's name on the books of the Fund. Shareholders of a class have
36
exclusive voting rights regarding any matter submitted to shareholders that
relates solely to that class of shares (such as a distribution plan or service
agreement relating to that class), and separate voting rights on any other
matter submitted to shareholders in which the interests of the shareholders of
that class differ from the interests of holders of any other class.
The Fund will continue without limitation of time, provided however that:
1) Subject to the majority vote of the holders of shares of any portfolio of the
Fund outstanding, the Trustees may sell or convert the assets of such portfolio
to another investment company in exchange for shares of such investment company,
and distribute such shares, ratably among the shareholders of such portfolio;
2) Subject to the majority vote of shares of any portfolio of the Fund
outstanding, the Trustees may sell and convert into money the assets of such
portfolio and distribute such assets ratably among the shareholders of such
portfolio; and
3) Without the approval of the shareholders of any portfolio, unless otherwise
required by law, the Trustees may combine the assets of any two or more
portfolios into a single portfolio so long as such combination will not have a
material adverse effect upon the shareholders of such portfolio.
Upon completion of the distribution of the remaining proceeds or the remaining
assets of any portfolio as provided in paragraphs 1), 2), and 3) above, that
portfolio shall terminate and the Trustees shall be discharged of any and all
further liabilities and duties hereunder and the right, title and interest of
all parties shall be canceled and discharged with regard to that portfolio.
Dividends and Distributions
The Fund's policy is to distribute substantially all of each portfolio's net
investment income, if any, together with any net realized capital gains in the
amount and at the times that will avoid both income (including capital gains)
taxes on it and the imposition of the federal excise tax on undistributed income
and capital gains (see discussion under "Dividends, Distributions and Taxes" in
the prospectus). The amounts of any income dividends or capital gains
distributions cannot be predicted.
Any dividend or distribution paid shortly after the purchase of shares of a
portfolio by an investor may have the effect of reducing the per share net asset
value of that portfolio by the per share amount of the dividend or distribution,
except for the Cash Reserves Portfolio. Furthermore, such dividends or
distributions, although in effect a return of capital, are subject to income
taxes as set forth in the prospectus.
As set forth in the prospectus, unless the shareholder elects otherwise in
writing, all dividends and distributions are automatically received in
additional shares of that portfolio of the Fund at net asset value (as of the
business day following the record date). This will remain in effect until the
Fund is notified by the shareholder in writing at least three days prior to the
record date that either the Income Option (income dividends in cash and capital
gains distributions in additional shares at net asset value) or the Cash Option
(both income dividends and capital gain distributions in cash) has been elected.
An account statement is sent to shareholders whenever a dividend or distribution
is paid.
Each portfolio of the Fund is treated as a separate entity (and hence, as a
separate "regulated investment company") for federal tax purposes. Any net
capital gains recognized by a portfolio are distributed to its investors without
need to offset (for federal income tax purposes) such gains against any net
capital losses of another portfolio.
37
Shareholder and Trustee Liability
Under Pennsylvania law, shareholders of a trust such as the Fund may, under
certain circumstances, be held personally liable as partners for the obligations
of the trust. The Fund's Declaration of Trust contains an express disclaimer of
shareholder liability for acts or obligations of the Fund and requires that
notice of such disclaimer be given in each agreement, obligation, or instrument
entered into or executed by the Fund or the Trustees, but this disclaimer may
not be effective in some jurisdictions or as to certain types of claims. The
Declaration of Trust further provides for indemnification out of the Fund's
property of any shareholder held personally liable for the obligations of the
Fund. The Declaration of Trust also provides that the Fund shall, upon request,
assume the defense of any claim made against any shareholder for any act or
obligation of the Fund and satisfy any judgment thereon. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which the Fund itself would be unable to meet its
obligations.
Pursuant to the Declaration of Trust, the Trustees may also authorize the
creation of additional series of shares (the proceeds of which would be invested
in separate, independently managed portfolios with distinct investment
objectives and policies and share purchase, redemption and net asset valuation
procedures) with such preferences, privileges, limitations and voting and
dividend rights as the Trustees may determine. All consideration received by the
Fund 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 Fund) and would be subject to the liabilities
related thereto. Pursuant to the 1940 Act shareholders of any additional series
or class of shares would normally have to approve the adoption of any advisory
contract relating to such series or class and of any changes in the investment
policies relating thereto.
The Declaration of Trust further provides that the Trustees will not be liable
for errors of judgment or mistakes of fact or law, but nothing in the
Declaration of Trust protects a Trustee against any liability to which he would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, or reckless disregard of the duties involved in the conduct of the
office.
PERFORMANCE INFORMATION
The Fund may from time to time quote various performance figures to illustrate
the past performance of its portfolios. Performance quotations by investment
companies are subject to rules adopted by the SEC, which require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Fund be accompanied by
certain standardized performance information computed as required by the SEC. An
explanation of the methods for computing performance follows.
Total Return
A portfolio's average annual total return is determined by finding the average
annual compounded rates of return over 1, 5, and 10 year periods (or, if
shorter, the period since inception of the portfolio) that would equate an
initial hypothetical $1,000 investment to its ending redeemable value. The
calculation assumes that all dividends and distributions are reinvested when
paid. The quotation assumes the amount was completely redeemed at the end of
each 1, 5, and 10 year period (or, if shorter, the period since inception of the
portfolio) and the deduction of all applicable Fund expenses on an annual basis.
When considering average total return figures for periods longer than one year,
it is important to note that a portfolio's annual total return for any one
period might have been greater or less than the average for the entire period.
Average annual total return is calculated according to the following formula:
38
P (1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000
payment made at the beginning of the stated period
The average annual total return of each Institutional Class portfolio of the
Fund for the periods noted is set forth below:
1 Year 5 Years 10 Years Inception
ended ended ended to Inception
9/30/97 9/30/97 9/30/97 9/30/97 Date
------- ------- -------- --------- ---------
Emerging Markets Value Portfolio 18.08 -- -- 15.71 02/28/95
Equity Portfolio 38.46 18.66 14.74 17.56 11/14/84
Growth Portfolio* N/A N/A N/A N/A N/A
International Equity Portfolio 23.16 12.30 -- 9.5 11/25/88
Mid Cap Growth Portfolio 28.05 22.77 -- 21.44 03/30/90
Mid Cap Value Portfolio 61.40 -- -- 42.61 12/30/94
Small Cap Value Portfolio 49.81 26.75 17.15 15.44 07/01/86
Value Portfolio 41.25 23.31 16.39 18.59 11/05/84
Cash Reserves Portfolio 5.32 4.48 -- 4.75 08/29/90
Domestic Fixed Income Portfolio 10.20 7.83 10.02 10.01 09/30/87
Fixed Income Portfolio 11.47 8.39 10.30 10.96 11/14/84
Fixed Income Portfolio II 10.58 7.69 -- 10.08 08/31/90
Global Fixed Income Portfolio 3.53 -- -- 7.36 04/30/93
Multi-Market Fixed Income Portfolio* N/A N/A N/A N/A N/A
High Yield Portfolio 19.90 14.03 -- 12.40 02/28/89
Intermediate Duration Portfolio 8.93 -- -- 8.87 10/03/94
International Fixed Income Portfolio 0.44 -- -- 6.81 04/29/94
Limited Duration Portfolio 6.98 5.19 -- 5.99 03/31/92
Mortgage-Backed Securities Portfolio 10.70 7.32 -- 7.50 01/31/92
Municipal Portfolio 8.47 -- -- 7.95 10/01/92
PA Municipal Portfolio 8.01 -- -- 8.28 10/01/92
Special Purpose Fixed Income Portfolio 11.78 8.90 -- 9.84 03/31/92
Balanced Portfolio 27.44 -- -- 14.53 12/31/92
Multi-Asset-Class Portfolio 26.50 -- -- 18.14 07/29/94
Balanced Plus Portfolio* N/A N/A N/A N/A N/A
Advisory Foreign Fixed Income Portfolio 14.08 -- -- 14.31 10/07/94
Advisory Mortgage Portfolio 11.03 -- -- 9.63 04/12/95
* The Growth, Balanced Plus and Multi-Market Fixed Income Portfolios had not
commenced operations as of September 30, 1997.
The average annual total return of each Investment Class portfolio of the Fund
for the periods noted is set forth below:
Inception
1 Year 5 Years 10 Years Inception Date of
ended ended ended to Investment
9/30/97 9/30/97 9/30/97 9/30/97 Class
------- ------- -------- --------- ---------
Equity Portfolio 38.12 -- -- 29.53 04/10/96
International Equity Portfolio 22.85 -- -- 16.24 04/10/96
Mid Cap Value Portfolio 61.05 -- -- 46.01 05/10/96
Value Portfolio 41.01 -- -- 32.09 05/06/96
Fixed Income Portfolio -- -- -- 10.07 10/15/96
High Yield Portfolio 19.77 -- -- 18.61 05/21/96
Special Purpose Fixed Income Portfolio 11.62 -- -- 10.83 04/10/96
Balanced Portfolio -- -- -- 18.40 04/04/97
39
Multi-Asset-Class Portfolio 26.32 -- -- 21.18 06/10/96
Balanced Plus Portfolio* -- -- -- -- N/A
* The Balanced Plus Portfolio had not commenced operations as of September 30,
1997.
The average annual total return of each Adviser Class portfolio of the Fund for
the periods noted is set forth below:
Inception
1 Year 5 Years 10 Years Inception Date of
ended ended ended to Adviser
9/30/97 9/30/97 9/30/97 9/30/97 Class
------- ------- ------- ------- -----
Mid Cap Growth Portfolio -- -- -- 27.99 01/31/97
Value Portfolio 40.87 -- -- 44.49 07/17/96
Fixed Income Portfolio -- -- -- 7.79 11/07/96
High Yield Portfolio -- -- -- 12.63 01/31/97
Balanced Portfolio -- -- -- 23.82 11/01/96
The portfolios may also calculate total return on an aggregate basis which
reflects the cumulative percentage change in value over the measuring period.
Aggregate total returns may be shown by means of schedules, charts or graphs and
may include subtotals of the various components of total return (e.g. income
dividends or returns for specific types of securities such as industry or
country types). The formula for calculating aggregate total return can be
expressed as follows:
Aggregate Total Return = [ ( ERV ) - 1 ]
---------------------------
P
The aggregate total return of each portfolio for the periods noted is set forth
below. One year aggregate total return figures and portfolio inception dates are
reflected under the annual total return figures provided above.
5 Years
ended Inception to
9/30/97 9/30/97
------- ------------
Emerging Markets Value Portfolio N/A 45.86%
Equity Portfolio 135.21% 702.87
Growth Portfolio** -- --
International Equity Portfolio 78.62 123.96
Mid Cap Growth Portfolio 178.94 329.47
Mid Cap Value Portfolio N/A 165.50
Small Cap Value Portfolio 227.21 403.11
Value Portfolio 185.13 802.03
Cash Reserves Portfolio 24.52 38.96
Domestic Fixed Income Portfolio 45.76 159.92
Fixed Income Portfolio 49.60 281.77
Fixed Income Portfolio II 44.81 97.47
Global Fixed Income Portfolio N/A 36.90
Multi-Market Fixed Income Portfolio** -- --
High Yield Portfolio 92.83 172.84
Intermediate Duration Portfolio N/A 28.94
International Fixed Income Portfolio N/A 25.29
Limited Duration Portfolio 28.81 37.70
Mortgage-Backed Securities Portfolio 42.40 50.58
Municipal Portfolio N/A 46.59
PA Municipal Portfolio N/A 48.80
Special Purpose Fixed Income Portfolio 53.13 67.63
Balanced Portfolio N/A 90.44
Multi-Asset-Class Portfolio N/A 69.69
Balanced Plus Portfolio** -- --
Advisory Foreign Fixed Income Portfolio N/A 48.97
Advisory Mortgage Portfolio N/A 25.44
40
* The above performance information relates solely to the Institutional Class.
Performance for the Investment Class and Adviser Class would be lower because
of the Shareholder Servicing fees and 12b-1 fees charged to the Investment
Class and Adviser Class, respectively.
** The Growth, Balanced Plus and Multi-Market Fixed Income Portfolios had not
commenced operations as of September 30, 1997.
The portfolios may also calculate a total return gross of all expenses which
reflects the cumulative percentage change in value over the measuring period
prior to the deduction of all fund expenses. The formula for calculating the
total return gross of all expenses can be expressed as follows:
Total Return Gross of all Expenses = ((ERV + E)/P) -1)
E = Fund expenses deducted from the ending redeemable value during the measuring
period.
The annualized since inception gross of fees returns of the Fund's portfolios
are set forth below:
Annualized Since
Inception
Period Ended:
9/30/97
MAS EQUITY FUNDS (Gross of Fees)*
Inception Date
- --------------
11/14/84 Equity Portfolio 18.29%
N/A Growth Portfolio --
11/05/84 Value Portfolio 19.33
07/01/86 Small Cap Value Portfolio 16.44
03/30/90 Mid Cap Growth Portfolio 22.17
11/25/88 International Equity Portfolio 10.22
12/30/94 Mid Cap Value Portfolio 43.71
02/28/95 Emerging Markets Value Portfolio 17.10
MAS FIXED INCOME FUNDS
11/14/84 Fixed Income Portfolio 11.50%
09/30/87 Domestic Fixed Income Portfolio 10.54
03/31/92 Special Purpose Income Portfolio 10.36
03/31/92 Limited Duration Portfolio 6.41
01/31/92 Mortgage-Backed Portfolio 8.12
02/28/89 High Yield Portfolio 13.07
10/01/92 Municipal Portfolio 8.56
10/01/92 PA Municipal Portfolio 8.82
04/30/93 Global Fixed Income Portfolio 8.02
N/A Multi-Market Fixed Income Portfolio --
04/29/94 International Fixed Income Portfolio 7.40
10/07/94 Advisory Foreign Fixed Income Portfolio 16.64
10/03/94 Intermediate Duration Portfolio 9.46
04/12/95 Advisory Mortgage Portfolio 9.72
MAS BALANCED FUNDS
12/31/92 Balanced Portfolio 15.16%
N/A Balanced Plus Portfolio --
07/29/94 Multi-Asset-Class Portfolio 18.90
*Annualized
41
As of September 30, 1997, the Growth, Multi-Market Fixed Income and Balanced
Plus Portfolios had not commenced operations.
The Municipal and PA Municipal Portfolio may also calculate a total return which
reflects the cumulative percentage change in value over the measuring period
after the deduction of income taxes. The formula for calculating the total after
tax return can be expressed as follows:
Total After Tax Return = (((((ERV-M)/P) x T) + (M/P)) -1)
M = Portion of ending redeemable value which was derived from tax exempt income.
T = Applicable tax rate.
The after tax returns are as follows for the Municipal and PA Municipal
Portfolios for the period 10/1/92 (inception of the Funds) through 9/30/97:
Pre-tax return Post-tax return
Municipal Portfolio 7.95*/46.59** 7.86*/45.98**
PA Municipal Portfolio 8.28*/48.80** 7.98*/46.79**
*Annualized
**Cumulative
The tax rates used were 31% federal and 2.8% Pennsylvania. All Municipal
Interest was considered exempt from federal taxes and interest from treasuries
was considered exempt from Pennsylvania.
Yield
In addition to total return, each portfolio of the Fund (except the Cash
Reserves Portfolio) may quote performance in terms of a 30-day yield. The yield
formula provides for semiannual compounding, which assumes that net investment
income is earned and reinvested at a constant rate and annualized at the end of
a six-month period. Methods used to calculate advertised yields are standardized
for all stock and bond mutual funds. However, these methods differ from the
accounting methods used by the portfolio to maintain its books and records,
therefore the advertised 30-day yield may not reflect the income paid to your
own account or the yield reported in the portfolios's reports to shareholders. A
portfolio may also advertise or quote a yield which is gross of expenses. The
yield figures provided will be calculated according to a formula prescribed by
the SEC and can be expressed as follows:
Yield = 2 [ ( (a-b/cd) + 1) 6 - 1 ]
Where:
a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
For the purpose of determining the interest earned (variable "a" in the formula)
on debt obligations that were purchased by a portfolio at a discount or premium,
the formula generally calls for amortization of the discount or
42
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market value of the debt obligations. The 30-day yield figures for each
of the Fund's fixed-income and equity portfolios is set forth below:
Period ending
9/30/97
-------
Emerging Markets Value Portfolio 1.02
Equity Portfolio 1.15
International Equity Portfolio 1.60
Mid Cap Growth Portfolio 0.00
Mid Cap Value Portfolio 0.08
Small Cap Value Portfolio 0.45
Value Portfolio 1.93
Domestic Fixed Income Portfolio 6.32
Fixed Income Portfolio 6.37
Fixed Income Portfolio II 6.66
Global Fixed Income Portfolio 5.30
High Yield Portfolio 8.60
Intermediate Duration Portfolio 6.34
International Fixed Income Portfolio 4.65
Limited Duration Portfolio 5.74
Mortgage-Backed Securities Portfolio 9.96
Municipal Portfolio 4.42
PA Municipal Portfolio 4.78
Special Purpose Fixed Income Portfolio 7.08
Balanced Portfolio 3.27
Multi-Asset-Class Portfolio 2.57
Advisory Foreign Fixed Income Portfolio 5.44
Advisory Mortgage Portfolio 7.39
As of September 30, 1997, the Growth, Balanced Plus and Multi-Market Fixed
Income Portfolios had not commenced operations.
* The above performance information relates solely to the Institutional Class.
Performance for the Investment Class and Adviser Class would be lower because of
the shareholder servicing fees and 12b-1 fees charged to the Investment Class
and Adviser Class, respectively.
Yield of the Cash Reserves Portfolio
The current yield of the Cash Reserves Portfolio is calculated daily on a base
period return of a hypothetical account having a beginning balance of one share
for a particular period of time (generally 7 days). The return is determined by
dividing the net change (exclusive of any capital changes) in such account by
the value of the account at the beginning of the period and then multiplying it
by 365/7 to get the annualized current yield. The calculation of net change
reflects the value of additional shares purchased with the dividends by the
portfolio, including dividends on both the original share and on such additional
shares. An effective yield, which reflects the effects of compounding and
represents an annualizing of the current yield with all dividends reinvested,
may also be calculated for the portfolio by dividing the base period return by
7, adding 1 to the quotient, raising the sum to the 365th power, and subtracting
1 from the results.
Set forth below is an example, for purposes of illustration only, of the current
and effective yield calculations for the Cash Reserves Portfolio for the 7 day
base period ending September 30, 1997.
Period ending
9/30/97
-------
Value at beginning of period $1.00
Value at end of period $1.00
43
Current yield 5.61%
Effective yield 5.46%
The net asset value per share of the Cash Reserves Portfolio is $1.00 and has
remained at that amount since the initial offering of the portfolio. The yield
of the portfolio will fluctuate. The annualizing of a week's dividend is not a
representation by the portfolio as to what an investment in the portfolio will
actually yield in the future. Actual yields will depend on such variables as
investment quality, average maturity, the type of instruments the portfolio
invests in, changes in interest rates on instruments, changes in the expenses of
the Fund and other factors. Yields are one basis investors may use to analyze
the portfolios of the Fund and other investment vehicles; however, yields of
other investment vehicles may not be comparable because of the factors set forth
in the preceding sentence, differences in the time periods compared and
differences in the methods used in valuing portfolio instruments, computing net
asset value and calculating yield.
The performance of a portfolio, as well as the composite performance of all
fixed-income portfolios and all equity portfolios, may be compared to data
prepared by Lipper Analytical Services, Inc., CDA Investment Technologies, Inc.,
Morningstar, Inc., the Donoghue Organization, Inc. or other independent services
which monitor the performance of investment companies, and may be quoted in
advertising in terms of their rankings in each applicable universe. In addition,
the Fund may use performance data reported in financial and industry
publications, including Barron's, Business Week, Forbes, Fortune, Investor's
Business Daily, IBC/Donoghue's Money Fund Report, Money Magazine, The Wall
Street Journal and USA Today.
COMPARATIVE INDICES
Each portfolio of the Fund may from time to time use one or more of the
following unmanaged indices for performance comparison purposes:
Consumer Price Index
The Consumer Price Index is published by the US Department of Labor and is a
measure of inflation.
Financial Times Actuaries World Ex US Index
The FT-A World Ex US Index is a capitalization-weighted price index, expressed
in dollars, after dividend withholding taxes, of foreign stock prices. This
index is calculated daily and reflects price changes in 24 major foreign equity
markets. It is jointly compiled by the Financial Times, Ltd., Goldman, Sachs &
Co., and County NatWest/Wood Mackenzie in conjunction with the Institute of
Actuaries and the Faculty of Actuaries. First Boston High Yield Index
The First Boston High Yield Index was constructed to mirror the public high
yield debt market. The index is a market weighted, trader priced index, tracked
by the First Boston Corporation. There are approximately 475 securities in the
index with a total market value of approximately $93 billion.
JP Morgan Traded Government Bond Index
The JP Morgan Traded Government Bond Index is designed to provide a
comprehensive measure of total return performance of the domestic Government
bond market of 13 countries. The index is maintained by JP Morgan Securities,
Inc. and includes only liquid issues.
44
J.P. Morgan Emerging Markets Bond Index
The J.P. Morgan Emerging Markets bond Index is a market-weighted index composed
of all Brady Bonds outstanding and includes Argentina, Brazil, Bulgaria, Mexico,
Nigeria, the Philippines, Poland and Venezuela.
Lehman Brothers 5-Year Municipal Bond Index
Lehman Brothers 5-Year Municipal Bond Index is a total return performance
benchmark for the intermediate investment grade tax exempt bond market. the
index includes general obligation bonds, revenue bonds, insured bonds and
prefunded bonds with maturities between 4 and 6 years.
Lehman Brothers 10-Year Municipal
Lehman Brothers 10-Year Municipal Bond Index is a total return performance
benchmark for the long term, investment grade tax exempt bond market. The index
includes general obligation bonds, revenue bonds, insured bonds and prefunded
bonds with maturities between 8 and 12 years.
Lehman Brothers Aggregate Index
The Lehman Brothers Aggregate Index is a fixed income market value-weighted
index that combines the Lehman Brothers Government/Corporate Index and the
Lehman Brothers Mortgage-Backed Securities Index. It includes fixed rate issues
of investment grade (BBB) or higher, with maturities of at least one year and
outstanding par values of at least $100 million for U. S. Government issues and
$25 million for others.
Lehman Brothers Government/Corporate Index
The Lehman Brothers Government/Corporate Index is a combination of the
Government and Corporate Bond Indices. The Government Index includes public
obligations of the U. S. Treasury, issues of Government agencies, and corporate
debt backed by the U. S. Government. The Corporate Bond Index includes
fixed-rate nonconvertible corporate debt. Also included are Yankee Bonds and
nonconvertible debt issued by or guaranteed by foreign or international
governments and agencies. All issues are investment grade (BBB) or higher, with
maturities of at least one year and an outstanding par value of at least $100
million for U. S. Government issues and $25 million for others. Any security
downgraded during the month is held in the index until month-end and then
removed. All returns are market value weighted inclusive of accrued income.
Lehman Brothers Intermediate Government/Corporate Index
The Lehman Brothers Intermediate Government/Corporate Index is a combination of
the Government and Corporate Bond Indices. All issues are investment grade (BBB)
or higher, with maturities of one to ten years and an outstanding par value of
at least $100 million for U. S. Government issues and $25 million for others.
The Government Index includes public obligations of the U. S. Treasury, issues
of Government agencies, and corporate debt backed by the U. S. Government. The
Corporate Bond Index includes fixed-rate nonconvertible corporate debt. Also
included are Yankee Bonds and nonconvertible debt issued by or guaranteed by
foreign or international governments and agencies. Any security downgraded
during the month is held in the index until month-end and then removed. All
returns are market value weighted inclusive of accrued income.
Lehman Brothers Long Municipal Bond Index
The Lehman Brothers Long Municipal Bond Index is a total return for the
long-term, investment-grade tax-exempt bond market for bonds. The index includes
municipal bonds with maturities of 22 years or more.
45
Lehman Brothers Mortgage-Backed Securities Index
The Lehman Brothers Mortgage-Backed Securities Index includes fixed rate
mortgage securities backed by GNMA, FHLMC, and FNMA. Graduated Payment Mortgages
(GPM's) are included. All issues are AAA, with maturities of at least one year
and outstanding par values of at least $100 million. Returns are market value
weighted inclusive of accrued income.
Lipper Growth & Income Fund Index
The Lipper Growth & Income Fund Index is a net asset value weighted index of the
30 largest Funds within the Growth & Income investment objective. It is
calculated daily with adjustments for income dividends and capital gains
distributions as of the ex-dividend dates.
Lipper High Current Yield Fund Average
The Lipper High Current Yield Fund Average reports the average return of all the
Funds tracked by Lipper Analytical Services, Inc. classified as high yield
funds. The number of Funds tracked varies. As a result, reported returns for
longer time periods do not always match the linked product of shorter period
returns.
Salomon World Government Bond Index ex US
The Salomon World Government Bond Index ex US is designed to provide a
comprehensive measure of total return performance of the domestic government
bond markets of 12 countries outside the U.S. The index has been constructed
with the aim of choosing "an inclusive" universe of institutionally traded fixed
rate bonds. The selection of security types to be included in the index is made
with the aim of being as comprehensive as possible, while satisfying the
criterion of reasonable availability to domestic and international institutions
and the existence of complete pricing and market profile data.
International Finance Corporation Emerging Markets Index
The IFC Emerging Markets Index is an index designed to measure the total return
in either US or local currency terms of developing markets as defined by the
World Bank. The selection of stocks is made based on size, liquidity and
industry.
The weight given to any stock is determined by its market capitalization.
Lipper Money Market Average
The Lipper Money Market Average reports the average return of all the Funds
tracked by Lipper Analytical Services, Inc., classified as money market Funds
for any given period. The number of Funds tracked varies. As a result, reported
returns for longer time periods do not always match the linked product of
shorter period returns.
Merrill Lynch Corporate & Government Bond Index
The Merrill Lynch Corporate & Government Bond Index includes over 4,500 U.S.
Treasury, Agency and investment grade corporate bonds. The Index is calculated
daily and will be used from time to time in performance comparison for partial
month periods.
Morgan Stanley Capital International World ex USA Index
The Morgan Stanley Capital International World ex USA Index is a
capitalization-weighted price index expressed in dollars. The index reflects the
performance of over 1,100 companies in 19 foreign equity markets. The index
includes dividends, net of foreign withholding taxes.
46
Morgan Stanley Capital International EAFE Index
The Morgan Stanley Capital International EAFE Index is an arithmetic, market
value-weighted average of the performance of over 900 securities listed on the
stock exchanges of countries in Europe, Australia and the Far East.
Morgan Stanley Capital International EAFE-GDP Weighted Index
The EAFE-GDP index is an arithmetic average of the performance of over 900
securities listed on the stock exchanges of countries in Europe, Australia and
the Far East. The index is weighted by the Grow Domestic Product of the various
countries in the index.
Morgan Stanley Capital International Emerging Markets Free Index
The MSCI Emerging Markets Free Index is a capitalization weighted index of over
800 stocks from 17 different emerging market countries.
Nasdaq Industrials Index
The Nasdaq Industrials Index is a measure of all Nasdaq National Market System
issues classified as industrial based on Standard Industrial Classification
codes relative to a company's major source of revenue. The index is exclusive of
warrants, and all domestic common stocks traded in the regular Nasdaq market
which are not part of the Nasdaq National Market System. The Nasdaq Industrials
Index is market value weighted.
Russell 1000
The Russell 1000 Index consists of the 1,000 largest of the 3,000 largest
stocks. Market capitalization is typically between $610 million and $85 billion.
The list is rebalanced each year on June 30. If a stock is taken over or goes
bankrupt, it is not replaced until rebalancing. Therefore, there can be fewer
than 1,000 stocks in the Russell 1000 Index. The index is an equity market
capitalization weighted index available from Frank Russell & Co. on a monthly
basis.
Russell 2000
The Russell 2000 Index consists of the 2,000 smallest of the 3,000 largest
stocks. Market capitalization is typically between $610 million and $57 million.
The list is rebalanced each year on June 30. If a stock is taken over or goes
bankrupt, it is not replaced until rebalancing. Therefore, there can be fewer
than 2,000 stocks in the Russell 2000 Index. The index is an equity market
capitalization weighted index available from Frank Russell & Co. on a monthly
basis.
Russell 2500
The Russell 2500 Index consists of the 2,500 smallest of the 3,000 largest
stocks. Market capitalization is typically between $1.7 billion and $57 million.
The list is rebalanced each year on June 30. If a stock is taken over or goes
bankrupt, it is not replaced until rebalancing. Therefore, there can be fewer
than 2,500 stocks in the Russell 2500 Index. The index is an equity market
capitalization weighted index available from Frank Russell & Co. on a monthly
basis.
47
Russell 3000
The Russell 3000 Index is a combination of the Russell 1000 Index and the
Russell 2000 Index.
Salomon 1-3 Year Treasury/Government Sponsored Index
The Salomon 1-3 Year Treasury/Government Sponsored Index includes U.S. Treasury
and agency securities with maturities one year or greater and less than three
years. Securities with amounts outstanding of at least $25 million are included
in the index.
Salomon 1-3 Year Treasury/Government Sponsored/Corporate Index
The Salomon 1-3 Year Treasury/Government Sponsored/Corporate Index includes U.S.
Treasury, agency and investment grade (BBB or better) securities with maturities
one year or greater and less than three years. Securities with amounts
outstanding of at least $25 million are included in the index.
Salomon Broad Index
The Salomon Broad Index, also known as the Broad Investment Grade (BIG) Index,
is a fixed income market capitalization-weighted index, including U. S.
Treasury, agency, mortgage and investment grade (BBB or better) corporate
securities with maturities of one year or longer and with amounts outstanding of
at least $25 million. The government index includes traditional agencies; the
mortgage index includes agency pass-throughs and FHA and GNMA project loans; the
corporate index includes returns for 17 industry sub-sectors. Securities
excluded from the Broad Index are floating/variable rate bonds, private
placements, and derivatives (e. g., U. S. Treasury zeros, CMOs, mortgage
strips). Every issue is trader-priced at month-end and the index is published
monthly.
Salomon High-Yield Market Index
The Salomon High-Yield Market Index includes public, non-convertible corporate
bond issues with at least one year remaining to maturity and $50 million in par
amount outstanding which carry a below investment-grade quality rating from
either Standard & Poor's or Moody's rating services.
Salomon Mortgage Index
The Salomon Mortgage Index includes agency pass-throughs (GNMA, FHLMC, FNMA) and
FHA and GNMA project loans. Pools with remaining terms shorter than 25 years are
seasoned; pools with longer terms are classified as new. The index is published
monthly.
Salomon One To Three Year Treasury Index
The Salomon One To Three Year Treasury Index includes only U.S. Treasury Notes
and Bonds with maturities one year or greater and less than three years.
Salomon World Government Bond Index
The Salomon World Government Bond Index is designed to provide a comprehensive
measure of total return performance of the domestic Government bond market of
thirteen countries. The index has been constructed with the aim of choosing an
"all inclusive" universe of institutionally traded fixed-rate bonds. The
selection of security types to be included in the index is made with the aim of
being as comprehensive as possible, while satisfying the criterion of reasonable
availability to domestic and international institutions and the existence of
complete pricing and market profile data.
48
S&P 500
The S&P 500 is a portfolio of 500 stocks designed to mimic the overall equity
market's industry weightings. Most, but not all, large capitalization stocks are
in the index. There are also some small capitalization names in the index. The
list is maintained by Standard & Poor's Corporation. It is market capitalization
weighted. Unlike the Russell indices, there are always 500 names in the S&P 500.
Changes are made by Standard & Poor's as needed.
S&P Mid Cap 400 Index
The S&P Mid Cap 400 Index consists of 400 domestic stocks chosen for market
size, liquidity, and industry group representation. It is also a market-value
weighted index and was the first benchmark of mid cap stock price movement.
S&P/BARRA Mid Cap 400 Growth Index
The S&P/BARRA Mid Cap 400 Growth Index is constructed by dividing the stocks in
the S&P MidCap 400 Index according to a single attribute: price-to-book ratios.
The MidCap 400 Growth Index is composed of firms with higher price-to-book
ratios. Like the MidCap 400, the MidCap 400 Growth Index is
capitalization-weighted, meaning that each stock is weighted in the appropriate
index in proportion to its market value.
S&P 500 Ex South Africa Index
The S&P 500 Ex South Africa Index is the same as the S&P 500 Index excluding
companies that are on the Investor Responsibility Research Center (IRRC) list of
companies doing business in South Africa. This index is maintained by Wilshire
Associates.
Wilshire 5000 Equity Index
The Wilshire 5000 Equity Index measures performance of all US headquartered
equity securities with readily available price data. Approximately 6,000
capitalization weighted security returns are used to calculate the index.
49
FINANCIAL STATEMENTS
The Fund's Financial Statements for the fiscal year ended September 30, 1997,
including notes thereto and the report of Price Waterhouse LLP thereon are
incorporated herein by reference. A copy of the 1997 Annual Report will
accompany the delivery of this Statement of Additional Information. In the 1997
Annual Report, the Emerging Markets Value Portfolio is referred to as the
Emerging Markets Portfolio. The portfolio changed its name following the
printing of the Annual Report. In addition, the 1997 Annual Report includes
financial information for the Investment Class of the Special Purpose Fixed
Income Portfolio. Following the printing of the Annual Report, the Fund closed
the Investment Class of this portfolio. Accordingly, this portfolio has been
removed from the Investment Class prospectus.
APPENDIX-DESCRIPTION OF SECURITIES AND RATINGS
I. Description of Bond Ratings
Excerpts from Moody's Investors Service, Inc.'s Corporate Bond Ratings:
Aaa: judged to be the best quality; carry the smallest degree of investment
risk; Aa--judged to be of high quality by all standards; A: possess many
favorable investment attributes and are to be considered as higher medium grade
obligations; Baa: considered as lower medium grade obligations, i.e., they are
neither highly protected nor poorly secured; Ba: B: protection of interest and
principal payments is questionable.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest. Ca: Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings. C: Bonds which are rated C are lowest rated class of bonds
and issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
Note: Moody's may apply numerical modifiers, 1,2 and 3 in each generic rating
classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Excerpts from Standard & Poor's Corporation's Corporate Bond Ratings:
AAA: highest grade obligations; possess the ultimate degree of protection as to
principal and interest; AA: also qualify as high grade obligations, and in the
majority of instances differs from AAA issues only in small degree; A: regarded
as upper medium grade; have considerable investment strength but are not
entirely free from adverse effects of changes in economic and trade conditions.
Interest and principal are regarded as safe; BBB: regarded as borderline between
definitely sound obligations and those where the speculative element begins to
predominate; this group is the lowest which qualifies for commercial bank
investments.
BB, B, CCC, CC, C: Debt rated BB, B, CCC, CC and C is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
CI: The rating CI is reserved for income bonds on which no interest is being
paid. D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S&P's believes
50
that such payments will be made during such grace period. The D rating also will
be used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Plus(+) or Minus(-): The ratings from "AA" to "CCC" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Excerpts from Fitch Investors Services, Inc. Corporate Bond Ratings:
AAA: Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
AA: Bonds considered to be investment grade and of very high credit quality. The
obligor's ability to pay interest and repay principal is very strong, although
not quite as strong as bonds rated "AAA". Because bonds rated in the "AAA" and
"AA" categories are not significantly vulnerable to foreseeable future
developments, short term debt of these issuers is generally rated "-,+".
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit quality.
The obligor's ability to pay interest and repay principal is considered to be
adequate. Adverse changes in economic conditions and circumstances, however, are
more likely to have adverse impact on these bonds, and therefore impair timely
payment. The likelihood that the ratings of these bonds will fall below
investment grade is higher than for bonds with higher ratings.
BB: Bonds are considered speculative. The obligor's ability to pay interest and
repay principal may be affected over time by adverse economic changes. However,
business and financial alternatives can be identified which could assist the
obligor in satisfying its debt service requirements.
B: Bonds are considered highly speculative. While bonds in this class are
currently meeting debt service requirements, the probability of continued timely
payment of principal and interest reflects the obligor's limited margin of
safety and the need for reasonable business and economic activity throughout the
life of the issue.
CCC: Bonds have certain identifiable characteristics which, if not remedied, may
lead to default. The ability to meet obligations requires an advantageous
business and economic environment.
CC: Bonds are minimally protected. Default in payment of interest and/or
principal seems probable over time.
C: Bonds are in imminent default in payment of interest or principal.
DDD, DD, and D: Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis of their
ultimate recovery value in liquidation or reorganization of the obligor. "DDD"
represents the highest potential for recovery on the these bonds, and "D"
represents the lowest potential for recovery.
Plus (+) Minus(-) Plus and minus signs are used with a rating symbol to indicate
the relative position of a credit within the rating category. Plus and minus
signs, however, are not used in the "DDD", "DD", or "D" categories.
51
Excerpts from Duff & Phelps Corporate Bond Ratings:
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA+, AA, AA-: High credit quality. Protection factors are strong. Risk is modest
but may vary slightly from time to time of economic conditions.
A+, A, A-: Protection factors are average but adequate. However, risk factors
are more variable and greater in periods of economic stress.
BBB+,BBB, BBB-: Below average protection factors but still considered sufficient
for prudent investment. Considerable variability in risk during economic cycles.
BB+, BB, BB-: Below investment grade but deemed likely to meet obligations when
due. Present or prospective financial protection factors fluctuate according to
industry conditions or company fortunes. Overall quality may move up or down
frequently within this category.
B+, B, B-: Below investment grade and possessing risk that obligations will not
be met when due. Financial protection factors will fluctuate widely according to
economic cycles, industry conditions and/or company fortunes. Potential exists
for frequent changes in the rating within this category or into a higher or
lower rating grade.
CCC: Well below investment grade securities. Considerable uncertainty exists as
to timely payment of principal, interest or preferred dividends. Protections
factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
DD: Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP: Preferred stock with dividend arrearage.
Description of Bond Ratings
Excerpts from Moody's Investors Service, Inc.'s Preferred Stock Ratings
aaa: An issue which is rated aaa is considered to be a top-quality preferred
stock. This rating indicates good asset protection and the least risk of
dividend impairment within the universe of preferred stocks. aa: An issue which
is rated aa is considered a high-grade preferred stock. This rating indicates
that there is reasonable assurance that earnings and asset protection will
remain relatively well maintained in the foreseeable future. a: An issue which
is rated a is considered to be an upper medium grade preferred stock. While
risks are judged to be somewhat greater than in the aaa and aa classifications,
earnings and asset protection are, nevertheless expected to be maintained at
adequate levels. baa: An issue which is rated baa is considered to be medium
grade, neither highly protected nor poorly secured. Earnings and asset
protection appear adequate at present but may be questionable over any great
length of time. ba: an issue which is rated ba is considered to have speculative
elements and its future cannot be considered well assured. Earnings and asset
protection may be very moderate and not well safeguarded during adverse periods.
Uncertainty of position characterizes preferred stocks in this class. b: An
issue which is rated b generally lacks the characteristics of a desirable
investment. Assurance of dividend payments and maintenance of other terms of the
issue over any long period of time may be small. caa: An issue which is rated
caa is likely to be in arrears on dividend payments. This rating designation
does not purport to indicate the future status of payment. ca: An issue which is
rated ca is speculative in a high degree an is likely to be in arrears on
dividends with little
52
likelihood of eventual payment. c: This is the lowest rated class of preferred
of preference stock. Issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing.
Note: Moody's may apply numerical modifiers 1,2 and 3 in each rating
classification from "aa "through "b" in its preferred stock rating system. The
modifier 1 indicated that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range raking; and the modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
Excerpts from Standard & Poor's Corporation's Preferred Stock Ratings
AAA: This is the highest rating that may be assigned by S&P's to a preferred
stock issue and indicates an extremely strong capacity to pay the preferred
stock obligations. AA: A preferred stock issue rated AA also qualifies as a high
quality fixed income security. The capacity to pay preferred stock obligations
is very strong, although not as overwhelming as for issues rated AAA. A: An
issue rated A is backed by a sound capacity to pay the preferred stock
obligations , although it is somewhat more susceptible to the adverse effect of
the changes in circumstances and economic conditions. BBB: An issue rated BBB is
regarded as backed by an adequate capacity to pay the preferred stock
obligations. Whereas it normally exhibits adequate protection parameter, adverse
economic conditions or changing circumstances are more likely to lead to a
weakened capacity to make payments for a preferred stock in this category than
for issues in the A category. BB,B,CCC: Preferred stock rated BB, B, and CCC are
regarded, on balance, as predominantly speculative with respect to the issuer's
capacity to pay preferred stock obligations. Bb indicates the lowest degree of
speculation and CCC the highest degree of speculation. While such issues will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties of major risk exposures to adverse conditions. CC: The
rating CC is reserved for a preferred stock in arrears on dividends or sinking
fund payments but that is currently paying. C: A preferred stock rated C is a
non-paying issue. D: A preferred stock rated D is a non-paying issue with the
issuer in default on debt instruments.
Plus(+) or Minus(-): The ratings from "AA" for "B" may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
Excerpts from Fitch Investors Services, Inc. Preferred Stock Ratings:
AAA: Preferred stocks assigned this rating are the highest quality. Strong asset
protection, conservative balance sheet ratios, and positive indications of
continued protection of preferred dividend requirements are prerequisites for an
"AAA" rating.
AA: Preferred of preference issues assigned this rating are good quality. Asset
protection and coverages of preferred dividends are considered adequate and are
expected to be maintained.
A: Preferred of preference issues assigned this rating are good quality. Asset
protection and coverages of preferred dividends are considered adequate and are
expected to be maintained.
BBB: Preferred or preference issues assigned this rating are reasonably safe but
lack the protections of the "A" to "AAA" categories. Current results should be
watched for possible of deterioration.
BB: Preferred or preference issues assigned this rating are considered
speculative. The margin of protection is slim or subject to wide fluctuations.
The loner-term financial capacities of the enterprises cannot be predicted with
assurance.
B: Issues assigned this rating are considered highly speculative. While earnings
should normally cover dividends,
53
directors may reduce or omit payment due to unfavorable developments, inability
to finance, or wide fluctuations in earnings.
CCC: Issues assigned this rating are extremely speculative and should be
assessed on their prospects in a possible reorganization. Dividend payments may
be in arrears with the status of the current dividend uncertain.
CC: Dividends are not currently being paid and may be in arrears. The outlook
for future payments cannot be assured.
C: Dividends are not currently being paid and may be in arrears. Prospects for
future payments are remote.
D: Issuer is in default on its debt obligations and has filed for reorganization
or liquidation under the bankruptcy law.
Plus (+) Minus (-) Plus and minus signs are used with a rating symbol to
indicate the relative position of a credit within the rating category. Plus and
minus signs, however, are not used in the "AAA", "CCC", "CC", "C", and "D"
categories.
54