-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: keymaster@town.hall.org Originator-Key-Asymmetric: MFkwCgYEVQgBAQICAgADSwAwSAJBALeWW4xDV4i7+b6+UyPn5RtObb1cJ7VkACDq pKb9/DClgTKIm08lCfoilvi9Wl4SODbR1+1waHhiGmeZO8OdgLUCAwEAAQ== MIC-Info: RSA-MD5,RSA, bdgmLEBg/tz49BqoQVhNO+5kvX6tXN0JGMF6hZYVR4sdqOf2xqwWeNRNqh4qVD7h mS8ENioEbsf2eE8ucYbBbQ== 0000757440-95-000012.txt : 19950601 0000757440-95-000012.hdr.sgml : 19950601 ACCESSION NUMBER: 0000757440-95-000012 CONFORMED SUBMISSION TYPE: 485BPOS PUBLIC DOCUMENT COUNT: 64 FILED AS OF DATE: 19950301 EFFECTIVENESS DATE: 19950301 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST UNION FUNDS/ CENTRAL INDEX KEY: 0000757440 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 046599663 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1933 Act SEC FILE NUMBER: 002-94560 FILM NUMBER: 95517338 FILING VALUES: FORM TYPE: 485BPOS SEC ACT: 1940 Act SEC FILE NUMBER: 811-04154 FILM NUMBER: 95517339 BUSINESS ADDRESS: STREET 1: 99 HIGH ST CITY: BOSTON STATE: MA ZIP: 02110 BUSINESS PHONE: 6173383200 MAIL ADDRESS: STREET 1: FEDERATED INVESTORS TOWER CITY: PITTSBURGH STATE: PA ZIP: 15222-3779 FORMER COMPANY: FORMER CONFORMED NAME: FIRST UNION HIGH GRADE TAX FREE PORT DATE OF NAME CHANGE: 19940519 FORMER COMPANY: FORMER CONFORMED NAME: FIRST UNION FUNDS DATE OF NAME CHANGE: 19921230 FORMER COMPANY: FORMER CONFORMED NAME: SALEM FUNDS DATE OF NAME CHANGE: 19920703 485BPOS 1 1933 Act File No. 2-94560 1940 Act File No. 811-4154 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form N-1A REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 X Pre-Effective Amendment No. Post-Effective Amendment No. 39 X and/or REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940 X Amendment No. 39 X FIRST UNION FUNDS (Exact Name of Registrant as Specified in Charter) Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779 (Address of Principal Executive Offices) (412) 288-1900 (Registrant's Telephone Number) John W. McGonigle, Esquire, Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779 (Name and Address of Agent for Service) It is proposed that this filing will become effective: immediately upon filing pursuant to paragraph (b) X on February 28, 1995, pursuant to paragraph (b) 60 days after filing pursuant to paragraph (a) (i) on pursuant to paragraph (a) (i). 75 days after filing pursuant to paragraph (a)(ii) on _________________ pursuant to paragraph (a)(ii) of Rule 485. If appropriate, check the following box: This post-effective amendment designates a new effective date for a previously filed post-effective amendment. Registrant has filed with the Securities and Exchange Commission a declaration pursuant to Rule 24f-2 under the Investment Company Act of 1940, and: X_ filed the Notice required by that Rule on February 16, 1995; or intends to file the Notice required by that Rule on or about ____________; or during the most recent fiscal year did not sell any securities pursuant to Rule 24f-2 under the Investment Company Act of 1940, and, pursuant to Rule 24f-2(b)(2), need not file the Notice. Copies to: John A. Dudley, Esquire Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 CROSS REFERENCE SHEET This Amendment to the Registration Statement of FIRST UNION FUNDS, which is comprised of seventeen portfolios: (1) First Union Value Portfolio, (2) First Union Fixed Income Portfolio, (3) First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio), (4) First Union Tax Free Money Market Portfolio, (5) First Union Money Market Portfolio, (6) First Union Treasury Money Market Portfolio, (7) First Union Balanced Portfolio, (8) First Union Managed Bond Portfolio, (9) First Union North Carolina Municipal Bond Portfolio, (10) First Union U.S. Government Portfolio, (11) First Union Florida Municipal Bond Portfolio, (12) First Union Georgia Municipal Bond Portfolio, (13) First Union Virginia Municipal Bond Portfolio, (14) First Union Utility Portfolio, (15) First Union South Carolina Municipal Bond Portfolio; (16) First Union Emerging Markets Growth Portfolio; and (17) First Union International Equity Portfolio. Each of the portfolios consist of four separate classes of shares: (a) Y Shares, (b) Class A Investment Shares, (c) Class B Investment Shares, and (d) Class C Investment Shares, with the following exceptions: First Union North Carolina Municipal Bond Portfolio, First Union Florida Municipal Bond Portfolio, First Union Georgia Municipal Bond Portfolio, First Union Virginia Municipal Bond Portfolio, First Union South Carolina Municipal Bond Portfolio, which consists of: (a) Y Shares, (b) Class A Investment Shares, and (c) Class B Investment Shares; First Union Managed Bond Portfolio, which consists of: (a) Y Shares; First Union High Grade Tax Free Portfolio, which consists of: (a) Y Shares, (b) Class A Investment Shares, and (c) Class B Investment Shares; First Union Tax Free Money Market Portfolio and First Union Treasury Money Market Portfolio, which consist of: (a) Y Shares and (b) Class A Investment Shares. PART A. INFORMATION REQUIRED IN A PROSPECTUS. Prospectus Heading (Rule 404(c) Cross Reference) Item 1. Cover Page Cover Page. Item 2. Synopsis Summary of Fund Expenses. Item 3. Condensed Financial Information Financial Highlights. Item 4. General Description of Registrant Investment Objective and Policies; Other Investment Policies; Types of Investments. Item 5. Management of the Fund Management of First Union Funds; Fees and Expenses. Item 6. Capital Stock and Other Securities Distributions and Taxes; Shareholder Rights and Privileges; Tax Information; Other Classes of Shares. Item 7. Purchase of Securities Being Offered Shareholder Guide; How to Buy Shares. Item 8. Redemption or Repurchase How to Redeem Shares; How to Convert Your Investment from One First Union Fund to Another First Union Fund; Additional Shareholder Services [(1,2,3,5,7,9-15) b-c; (4,6)b; (16, 17) b,c and d]. Item 9. Pending Legal Proceedings None. PART B. INFORMATION REQUIRED IN A STATEMENT OF ADDITIONAL INFORMATION. Item 10. Cover Page Cover Page. Item 11. Table of Contents Table of Contents. Item 12. General Information and History General Information about the Fund. Item 13. Investment Objectives and Policies Investment Objective and Policies; Investment Limitations. Item 14. Management of the Fund First Union Funds Management and Trustees Compensation. Item 15. Control Persons and Principal Holders of Securities Fund Ownership. Item 16. Investment Advisory and Other Services Investment Advisory Services; Administrative Services. Item 17. Brokerage Allocation Brokerage Transactions. Item 18. Capital Stock and Other Securities Not Applicable. Item 19. Purchase, Redemption and Pricing of Securities Being Offered Purchasing Shares; Determining Net Asset Value; Redeeming Shares. Item 20. Tax Status Tax Status. Item 21. Underwriters Not Applicable. Item 22. Calculation of Performance Data Yield (1-17); Effective Yield (4-6); Total Return (1-3, 7- 17); Tax-Equivalent Yield (3, 9, 11, 12, 13, 15); Performance Comparisons. Item 23. Financial Statements. Incorporated into the Statement of Additional Information by reference to the Growth Funds', Growth and Income Funds', Income Funds', Money Market Funds', and Tax Free Funds' Annual Reports. PROSPECTUS FIRST UNION INCOME FUNDS Y SHARES FEBRUARY 28, 1995 FIRST UNION INCOME FUNDS Portfolios of First Union Funds - --------------------- --------------------- - --------------------- --------------------- Y SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes three diversified Income Funds, three diversified Growth and Income Funds, two diversified Growth Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Income Funds .First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Y Shares of First Union Income Funds. It concisely describes the information which you should know before investing in Y Shares of any of the First Union Income Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Income Fund in its Statement of Additional Information dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-2584. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - -------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - -------------------------------------- -------------------------------------- - -------------------------------------- -------------------------------------- TABLE OF - ------------------------- ------------------------- - ------------------------- ------------------------- CONTENTS Summary 2 How to Convert Your Investment from - -------------------------------------- One First Union Fund to Another First Union Fund 25 Summary of Fund Expenses 4 -------------------------------------- - -------------------------------------- How to Redeem Shares 26 Financial Highlights 6 -------------------------------------- - -------------------------------------- Management of First Union Funds 26 Investment Objectives and Policies 11 -------------------------------------- - -------------------------------------- Fees and Expenses 27 First Union Fixed Income Portfolio 11 -------------------------------------- - -------------------------------------- Shareholder Rights and Privileges 29 First Union Managed Bond Portfolio 13 -------------------------------------- - -------------------------------------- Distributions and Taxes 30 First Union U.S. Government -------------------------------------- Portfolio 14 - -------------------------------------- Tax Information 31 -------------------------------------- Other Investment Policies 16 - -------------------------------------- Other Classes of Shares 31 -------------------------------------- Shareholder Guide 23 - -------------------------------------- Shareholder Reports 32 -------------------------------------- How to Buy Shares 24 - -------------------------------------- Addresses 33 -------------------------------------- SUMMARY - ------------------------- ------------------------- - ------------------------- ------------------------- DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Income Fund, except First Union Managed Bond Portfolio, is divided into four classes of shares: Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares") and Y Shares. Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). Class A Shares, Class B Shares and Class C Shares are sold to individuals and other customers of First Union (the "Adviser"). First Union Managed Bond Portfolio presently offers only Y Shares. This prospectus relates only to Y Shares ("Shares") of First Union Income Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following three Funds: . First Union Fixed Income Portfolio ("Fixed Income Fund")--seeks to provide a high level of current income by investing in a broad range of investment grade debt securities, with capital growth as a secondary objective; . First Union Managed Bond Portfolio ("Managed Bond Fund")--seeks to achieve total return; and . First Union U.S. Government Portfolio ("U.S. Government Fund")--seeks a high level of current income consistent with stability of principal. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Y Shares of any of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The market value of fixed income securities, which constitute a major part of the investments of the Funds described in this prospectus, may vary inversely in response to changes in prevailing interest rates. The foreign securities in which the Fixed Income Fund may invest may be subject to certain risks in addition to those inherent in U.S. investments. One or more Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, lending portfolio securities and entering into futures contracts and related options as hedges. These risks and those associated with investing in mortgage-backed securities, when-issued securities, options and variable rate securities are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF - ------------------------- ------------------------- - ------------------------- ------------------------- FUND EXPENSES FIRST UNION INCOME FUNDS Y SHARES Fixed Managed U.S. Income Bond Government Fund Fund Fund ------ ------- ---------- Y Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)................. None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................. None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable)......................................... None None None Redemption Fees (as a percentage of amount redeemed, if applicable)...................................... None None None Exchange Fee......................................... None None None Annual Y Shares Operating Expenses (As a percentage of average net assets) Management Fee....................................... 0.50% 0.50% 0.50% 12b-1 Fees........................................... None None None Total Other Expenses (after waiver) (1).............. 0.15% 0.20% 0.27% Total Y Shares Operating Expenses (2).............. 0.65% 0.70% 0.77% (1) Total Other Expenses for Managed Bond Fund would have been 0.21%, absent the voluntary waiver by the Administrator of certain of its fees. The Administrator may terminate this voluntary waiver at any time at its sole discretion. (2) The Total Y Shares Operating Expenses for Managed Bond Fund would have been 0.71%, absent the voluntary waiver described above in Note 1. U.S. Government Fund's Y Shares Annual Operating Expenses were 0.71%, for the year ended December 31, 1994. Total Y Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser would have been 0.75%, for the year ended December 31, 1994. The annual Y Shares Operating Expenses for U.S. Government Fund in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. SUMMARY OF - ------------------------- ------------------------- - ------------------------- ------------------------- FUND EXPENSES (continued) FIRST UNION INCOME FUNDS Y SHARES EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Y Shares. Fixed Income Fund............................ $7 $21 $36 $81 Managed Bond Fund............................ $7 $22 $39 $87 U.S. Government Fund......................... $8 $25 $43 $95 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Y Shares of the Funds. The Funds (other than Managed Bond Fund) also offer three additional classes of shares, called Class A Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales load of 4.75%. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. Class C Shares are subject to a 12b- 1 fee of 0.75 of 1% and a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. See "Fees and Expenses" and "Other Classes of Shares." FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund. Y Shares ------------------------------------ Year Ended December 31, ------------------------------------ 1994 1993 1992 1991* - ------------------------------------ -------- -------- -------- -------- Net asset value, beginning of period $10.43 $10.41 $10.54 $10.06 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.65 0.69 0.70 0.71 - ------------------------------------ Net realized and unrealized gain (loss) on investments (0.91) 0.19 (0.02) 0.56 - ------------------------------------ ------ ------ ------ ------ Total from investment operations (0.26) 0.88 0.68 1.27 - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.65) (0.68) (0.70) (0.71) - ------------------------------------ Distributions to shareholders from net realized gain on investment transactions -- (0.18) (0.11) (0.07) - ------------------------------------ Distributions in excess of net in- vestment income -- -- -- (0.01)(c) - ------------------------------------ ------ ------ ------ ------ Total distributions (0.65) (0.86) (0.81) (0.79) - ------------------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.52 $10.43 $10.41 $10.54 - ------------------------------------ ------ ------ ------ ------ Total return+ (2.55%) 8.67% 6.64% 13.80% - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.65% 0.66% 0.69% 0.69%(b) - ------------------------------------ Net investment income 6.56% 6.41% 6.67% 7.12%(b) - ------------------------------------ Expense waiver/reimbursement (a) -- -- -- 0.07%(b) - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $345,025 $376,445 $324,068 $256,254 - ------------------------------------ Portfolio turnover rate 48% 73% 66% 55% - ------------------------------------ * Reflects operations for the period from January 4, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the year ended December 31, 1991 were a result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Class A Investment Shares ----------------------------------------------- Year Ended Year Ended December 31, March 31, ----------------------------------------------- --------------- 1994 1993 1992 1991 1990* 1990 1989** - ------------------------ ------- ------- ------- ------- ------- ------ ------- Net asset value, begin- ning of period $10.42 $10.41 $10.54 $ 9.99 $ 9.72 $ 9.50 $ 9.70 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.65 0.65 0.71 0.73 0.55 0.79 0.10 - ------------------------ Net realized and unrealized gain (loss) on (0.91) 0.19 (0.06) 0.60 0.24 0.20 (0.14) investments - ------------------------ ------ ----- ------ ----- ----- ----- ------ Total from investment operations (0.26) 0.84 0.65 1.33 0.79 0.99 (0.04) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.64) (0.65) (0.67) (0.70) (0.52) (0.77) (0.16) - ------------------------ Distributions to share- holders from net realized gain on in- vestment transactions -- (0.18) (0.11) (0.07) -- -- -- - ------------------------ Distributions in excess of net investment income -- -- -- (0.01)(c) -- -- -- - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total distributions (0.64) (0.83) (0.78) (0.78) (0.52) (0.77) (0.16) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.52 $10.42 $10.41 $10.54 $ 9.99 $ 9.72 $ 9.50 - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total return+ (2.57%) 8.29% 6.39% 13.74% 8.31% 10.51% (0.31%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.75% 0.93% 0.90% 0.80% 1.01%(b) 1.00% 1.78%(b) - ------------------------ Net investment income 6.46% 6.15% 6.79% 7.30% 7.53%(b) 7.57% 6.10%(b) - ------------------------ Expense waiver/reimbursement (a) -- -- -- 0.09% 0.81%(b) 0.50% -- - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $19,127 $22,865 $21,488 $17,680 $11,765 $6,496 $11,580 - ------------------------ Portfolio turnover rate 48% 73% 66% 53% 27% 32% 18% - ------------------------
* Nine months ended December 31, 1990. ** Reflects operations for the period from January 28, 1989 (commencement of operations) to March 31, 1989. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the year ended December 31, 1991 were a result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------------------- ------------------------------------- - ------------------------------------- ------------------------------------- FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund. Class B Class C Investment Investment Shares Shares ---------------- ------------ Year Ended Year Ended December 31, December 31, ---------------- ------------ 1994 1993* 1994** - ------------------------------------------- -------- ------ ------------ Net asset value, beginning of period $10.44 $10.57 $ 9.85 - ------------------------------------------- Income from investment operations - ------------------------------------------- Net investment income 0.58 0.58 0.18 - ------------------------------------------- Net realized and unrealized gain (loss) on investments (0.92) 0.05 (0.30) - ------------------------------------------- ------ ------ ------ Total from investment operations (0.34) 0.63 (0.12) - ------------------------------------------- Less distributions - ------------------------------------------- Dividends to shareholders from net invest- ment income (0.56) (0.58) (0.18) - ------------------------------------------- Dividends to shareholders from net real- ized gain on investment transactions -- (0.18) -- - ------------------------------------------- ------ ------ ------ Total distributions (0.56) (0.76) (0.18) - ------------------------------------------- ------ ------ ------ Net asset value, end of period $ 9.54 $10.44 $ 9.55 - ------------------------------------------- ------ ------ ------ Total return+ (3.33%) 6.08% (1.27%) - ------------------------------------------- Ratios to Average Net Assets - ------------------------------------------- Expenses 1.50% 1.57%(a) 1.65%(a) - ------------------------------------------- Net investment income 5.75% 5.42%(a) 5.87%(a) - ------------------------------------------- Supplemental Data - ------------------------------------------- Net assets, end of period (000 omitted) $17,625 $8,876 $512 - ------------------------------------------- Portfolio turnover rate 48% 73% 48% - ------------------------------------------- * Reflects operations for the period from January 25, 1993, (commencement of operations) to December 31, 1993. **Reflects operations for the period from September 2, 1994, (commencement of operations) to December 31, 1994. +Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a)Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Managed Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund. Y Shares (a) ------------------------------------ Year Ended December 31, ------------------------------------ 1994 1993 1992 1991* - ------------------------------------ ------- -------- -------- -------- Net asset value, beginning of period $10.46 $10.34 $10.60 $10.00 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.66 0.65 0.66 0.49 - ------------------------------------ Net realized and unrealized gain (loss) on investments (1.11) 0.43 (0.08) 0.63 - ------------------------------------ ------ ------ ------ ------ Total from investment operations (0.45) 1.08 0.58 1.12 - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.66) (0.65) (0.66) (0.49) - ------------------------------------ Distributions to shareholders from net realized gain on investment transactions (0.00) (0.31) (0.18) (0.03) - ------------------------------------ ------ ------ ------ ------ Total distributions (0.66) (0.96) (0.84) (0.52) - ------------------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.35 $10.46 $10.34 $10.60 - ------------------------------------ ------ ------ ------ ------ Total return+ (4.40%) 10.59% 5.65% 11.63% - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.70% 0.70% 0.70% 0.70%(c) - ------------------------------------ Net investment income 6.68% 6.02% 6.30% 6.57%(c) - ------------------------------------ Expense waiver/reimbursement (b) 0.01% 0.03% 0.05% 0.00% - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $90,318 $109,067 $121,655 $112,984 - ------------------------------------ Portfolio turnover rate 32% 53% 56% 17% - ------------------------------------ * Reflects operations for the period from April 1, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Class A, Class B, and Class C Investment Shares were not being offered as of December 31, 1994. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Y Shares. (b) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union U.S. Government Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Y Shares Shares Shares Shares ----------------- ------------------ -------------------- ------------ Year Ended Year Ended Year Ended Year Ended December 31, December 31, December 31, December 31, ----------------- ------------------ -------------------- ------------ 1994 1993* 1994 1993** 1994 1993** 1994*** - ------------------------ ------- ------- ------- -------- ---------- --------- ------------ Net asset value, begin- ning of period $10.05 $10.25 $10.05 $10.00 $10.05 $10.00 $9.39 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.69 0.25 0.66 0.68 0.61 0.63 0.20 - ------------------------ Net realized and unrealized gain (loss) on investments (0.98) (0.20) (0.98) 0.05 (0.98) 0.05 (0.32) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations (0.29) 0.05 (0.32) 0.73 (0.37) 0.68 (0.12) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.69) (0.25) (0.66) (0.68) (0.61) (0.63) (0.20) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.07 $10.05 $ 9.07 $10.05 $ 9.07 $10.05 $9.07 - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total return+ (2.94%) 0.49% (3.18%) 7.43% (3.75%) 6.91% (1.30%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.71% 0.48%(b) 0.96% 0.68%(b) 1.54% 1.19%(b) 1.71%(b) - ------------------------ Net investment income 7.27% 7.20%(b) 6.97% 6.93%(b) 6.42% 6.44%(b) 6.70%(b) - ------------------------ Expense waiver/reimbursement (a) 0.04% 0.31%(b) 0.04% 0.31%(b) 0.04% 0.31%(b) 0.04%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $15,595 $14,486 $23,706 $38,851 $195,571 $236,696 $266 - ------------------------ Portfolio turnover rate 19% 39% 19% 39% 19% 39% 19% - ------------------------
* Reflects operations for the period from September 2, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. *** Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES - ------------------------- ------------------------- - ------------------------- ------------------------- AND POLICIES First Union Income Funds provide a broad range of objectives and policies, intended to offer investment alternatives to a large group of investors with a wide range of investment objectives. The investment objectives and policies of each Fund are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION FIXED INCOME - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: High level of current income with capital growth as a secondary objective. Invests in: A broad range of investment grade debt securities. Suitable for: Conservative investors who want attractive income. Key Benefit: Investors can participate in a broad portfolio of fixed income securities rather than purchasing a single issue. DESCRIPTION OF THE FUND The Fixed Income Fund seeks to provide a high level of current income by investing primarily in a broad range of investment grade debt securities. Capital growth is a secondary objective. The Fund will normally invest at least 80% of its assets in debt securities. At least 65% of the value of the portfolio will be invested in fixed income securities. TYPES OF INVESTMENTS While the Fund may invest in securities rated BBB by Standard & Poor's Ratings Group ("S&P") or Baa by Moody's Investors Service, Inc. ("Moody's"), the Adviser currently intends to limit the Fund's investments to securities rated A or higher by Moody's or S&P, or which, if unrated, are considered to be of comparable quality by the Adviser. Debt securities may include fixed, adjustable rate, zero coupon, or stripped securities, debentures, notes, U.S. government securities, and debt securities convertible into, or exchangeable for, preferred or common stock. Debt securities may also include mortgage-backed and asset-backed securities (which are more fully described under "First Union U.S. Government Portfolio--Types of Investments." Stated final maturity for these securities may range up to 30 years. The duration of the securities will not exceed 10 years. The Fund intends to maintain a dollar-weighted average maturity of 5 years or less. Market-expected average life will be used for certain types of issues in computing the average maturity. In normal market conditions the Fund may invest up to 20% of its assets in money market instruments consisting of: (1) high grade commercial paper, including master demand notes; (2) obligations of banks or savings and loan associations having at least $1 billion in deposits, including certificates of deposit and bankers' acceptances; (3) A-rated or better corporate obligations; (4) obligations issued or guaranteed by the U.S. government or by any agency or instrumentality of the U.S. government; and (5) repurchase agreements collateralized by any security listed above. The types of U.S. government securities in which the Fund may invest include: direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes and bonds; and notes, bonds, and discount notes of U.S. government agencies or instrumentalities, such as the: Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks, and Banks for Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal Home Loan Mortgage Corporation; Federal National Mortgage Association; Government National Mortgage Association; Student Loan Marketing Association; Tennessee Valley Authority; Export-Import Bank of the United States; Commodity Credit Corporation; Federal Financing Bank; and National Credit Union Administration (collectively, "U.S. government securities"). Some U.S. government agency obligations are backed by the full faith and credit of the U.S. Treasury. Others in which the Fund may invest are supported by: the issuer's right to borrow an amount limited to a specific line of credit from the U.S. Treasury; discretionary authority of the U.S. government to purchase certain obligations of an agency or instrumentality; or the credit of the agency or instrumentality. The Fund may also invest up to 20% of its assets in foreign securities (either foreign or U.S. securities traded in foreign markets) in order to provide further diversification. The Fund may also invest in preferred stock; units which are debt securities with stock or warrants attached; and obligations denominated in foreign currencies. In making these decisions, the Adviser will consider such factors as the condition and growth potential of various economies and securities markets, currency and taxation considerations and other pertinent financial, social, national and political factors. (See "Other Investment Policies" and "Foreign Investments.") The Fund may elect to use options and financial futures for hedging purposes as described in "Other Investment Policies--Options and Futures" and in the Fund's Statement of Additional Information. The Fund may also elect to use currency exchange contracts to manage exchange rate risk in order to stabilize the U.S. dollar value of a security that it has agreed to buy or sell. The Fund will not invest in securities judged to be speculative or of poor quality. TEMPORARY INVESTMENTS For temporary defensive purposes, the Fund may invest up to 100% of its assets in the money market instruments listed above. FIRST UNION MANAGED BOND - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Total return. Invests in: High grade corporate bonds and U.S. government and agency bonds. Suitable for: Conservative investors looking for bond interest and appreciation. Key Benefit: Provides a diversified portfolio of investment grade bonds featuring liquidity and security of capital. DESCRIPTION OF THE FUND The Managed Bond Fund is managed for total return which includes both changes in principal value of the Fund's portfolio and interest income. The Fund seeks to provide capital appreciation during periods of falling interest rates and protection against capital depreciation during periods of rising rates. To achieve total return, the Fund invests primarily in a professionally managed, diversified portfolio of high grade bonds with maturities up to 30 years. Under normal conditions, at least 65% of the value of the Fund's total assets will be invested in high grade corporate bonds and government and agency bonds. Financial futures may also be used depending upon the outlook for the economy. TYPES OF INVESTMENTS The Fund may invest in: domestic issues of corporate debt obligations rated A or better by Moody's or S&P; U.S. government securities as more fully described under "First Union Fixed Income Portfolio--Types of Investments;" commercial paper which matures in 270 days or less, with at least two high quality ratings by nationally recognized statistical rating organizations, e.g. A-1 or A-2 by S&P, or Prime-1 or Prime-2 by Moody's; time and savings deposits (including certificates of deposit) in commercial or savings banks whose accounts are insured by the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF") (both of which are administered by the Federal Deposit Insurance Corp. ("FDIC")), including certificates of deposit and other time deposits in foreign branches of banks insured by the BIF; bankers' acceptances (maximum 0.25% of the bank's total deposits according to the bank's last published statement of condition) issued by a bank insured by the BIF, or issued by the bank's Edge Act subsidiary and guaranteed by the bank, with remaining maturities of nine months or less; and repurchase agreements collateralized by eligible investments. TEMPORARY INVESTMENTS The Fund may also temporarily invest up to 100% of its assets in cash and cash items during times of unusual market conditions for defensive purposes. Cash items may include short term obligations, such as: rated commercial paper, time and savings deposits (including certificates of deposit), bankers' acceptances, obligations of the U.S. government or its agencies or instrumentalities, and repurchase agreements collateralized by eligible investments. RISK FACTORS Bond prices move inversely to interest rates, i.e. as interest rates decline, the values of the bonds increase and vice versa. The longer the maturity of a bond, the greater the exposure to market price fluctuations. The same market factors are reflected in the share price or net asset value of bond funds which will vary with interest rates. FIRST UNION U.S. GOVERNMENT - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: High level of current income consistent with stability of principal. Invests in: Debt instruments issued or guaranteed by the U.S. government, its agencies, or instrumentalities. Suitable for: Conservative investors seeking high current yields plus relative safety. Key Benefit: Active management of a blend of securities and maturities to maximize the opportunities and minimize the risks created by changing interest rates. DESCRIPTION OF THE FUND The U.S. Government Fund seeks a high level of current income consistent with stability of principal. The Fund seeks to achieve this objective by investing primarily in debt instruments which are U.S. government securities, as such term is defined under "First Union Fixed Income Portfolio--Types of Investments." As a matter of policy, the Fund will invest at least 65% of the value of its total assets in such U.S. government securities. TYPES OF INVESTMENTS In addition to U.S. government securities, the Fund may invest in: Securities representing ownership interests in mortgage pools ("mortgage- backed securities"). The yield and maturity characteristics of mortgage- backed securities correspond to those of the underlying mortgages, with interest and principal payments including prepayments (i.e. paying remaining principal before the mortgage's scheduled maturity) passed through to the holder of the mortgage-backed securities. The yield and price of mortgage-backed securities will be affected by prepayments which substantially shorten effective maturities. Thus, during periods of declining interest rates, prepayments may be expected to increase, requiring the Fund to reinvest the proceeds at lower interest rates, making it difficult to effectively lock in high interest rates. Conversely, mortgage-backed securities may experience less pronounced declines in value during periods of rising interest rates; Securities representing ownership interests in a pool of assets ("asset- backed securities"), for which automobile and credit card receivables are the most common collateral. Because much of the underlying collateral is unsecured, asset-backed securities are structured to include additional collateral and/or additional credit support to protect against default. The Adviser evaluates the strength of each particular issue of asset-backed security, taking into account the structure of the issue and its credit support. (See "Risk Characteristics of Asset-Backed Securities."); Collateralized mortgage obligations ("CMOs") issued by single-purpose, stand-alone entities. A CMO is a mortgage-backed security that manages the risk of repayment by separating mortgage pools into short, medium and long term portions. These portions are generally retired in sequence as the underlying mortgage loans in the mortgage pool are repaid. Similarly, as prepayments are made, the portion of CMO first to mature will be retired prior to its maturity, thus having the same effect as the prepayment of mortgages underlying a mortgage-backed security. The issuer of a series of CMOs may elect to be treated as a Real Estate Mortgage Investment Conduit (a "REMIC"), which has certain special tax attributes. The Fund will invest only in CMOs which are rated AAA by a nationally recognized statistical rating organization and which may be: (a) collateralized by pools of mortgages in which each mortgage is guaranteed as to payment of principal and interest by an agency or instrumentality of the U.S. government; (b) collateralized by pools of mortgages in which payment of principal and interest is guaranteed by the issuer and such guarantee is collateralized by U.S. government securities; or (c) securities in which the proceeds of the issuance are invested in mortgage securities and payment of the principal and interest are supported by the credit of an agency or instrumentality of the U.S. government. The Fund may invest up to 20% of its total assets in CMOs; Commercial paper which matures in 270 days or less so long as at least two of its ratings are high quality ratings by nationally recognized statistical rating organizations. Such ratings would include: A-1 or A-2 by S&P, Prime-1 or Prime-2 by Moody's, or F-1 or F-2 by Fitch Investors Service; Bonds and other debt securities rated Baa or higher by Moody's or BBB or higher by S&P, or which, if unrated, are considered to be comparable quality by the Adviser; Securities of other investment companies; and Repurchase agreements collateralized by eligible investments. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. TEMPORARY INVESTMENTS During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, the Fund may temporarily invest up to 100% of its assets in cash and cash items including such short term obligations as: commercial paper; U.S. government securities; and repurchase agreements collateralized by eligible investments. OTHER INVESTMENT - ------------------------ ------------------------ - ------------------------ ------------------------ POLICIES The Funds have adopted the following practices for specific types of investments. DOWNGRADES If any security invested in by any of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Fund's risk is the inability of the seller to pay the agreed-upon price on delivery date. However, this risk is tempered by the ability of the Fund to sell the security in the open market in the case of a default. In such a case, the Fund may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which a Fund purchases securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause a Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, a Fund may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, the Funds will not lend any of their assets except portfolio securities up to 15% (in the case of the Fixed Income and Managed Bond Funds) or one-third (in the case of the U.S. Government Fund) of the value of their total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. OPTIONS AND FUTURES All of the Funds may engage in options and futures transactions. Options and futures transactions are intended to enable a Fund to manage market, interest rate or exchange rate risk, and the Funds do not use these transactions for speculation or leverage. The Funds may attempt to hedge all or a portion of their portfolios through the purchase of both put and call options on their portfolio securities and listed put options on financial futures contracts for portfolio securities. The Funds may also write covered call options on their portfolio securities to attempt to increase their current income. The Funds will maintain their positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. The Funds may purchase listed put options on financial futures contracts. These options will be used only to protect portfolio securities against decreases in value resulting from market factors such as an anticipated increase in interest rates. The Funds may write (i.e., sell) covered call and put options. By writing a call option, a Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price. By writing a put option, a Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. The Funds also may write straddles (combinations of covered puts and calls on the same underlying security). The Funds may only write "covered" options. This means that so long as a Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. A Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of the put option, it deposits and maintains with its custodian in a segregated account liquid assets having a value equal to or greater than the exercise price of the option. The principal reason for writing call or put options is to obtain, through a receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Funds receive a premium from writing a call or put option which they retain whether or not the option is exercised. By writing a call option, the Funds might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Funds might become obligated to purchase the underlying securities for more than their current market price upon exercise. A futures contract is a firm commitment by two parties: the seller, who agrees to make delivery of the specific type of instrument called for in the contract ("going short"), and the buyer, who agrees to take delivery of the instrument ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt instruments issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. If a Fund would enter into financial futures contracts directly to hedge its holdings of fixed income securities, it would enter into contracts to deliver securities at an undetermined price (i.e., "go short") to protect itself against the possibility that the prices of its fixed income securities may decline during the Fund's anticipated holding period. A Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. The Funds may also enter into currency and other financial futures contracts and write options on such contracts. The Funds intend to enter into such contracts and related options for hedging purposes. The Funds will enter into futures on securities, currencies, or index-based futures contracts in order to hedge against changes in interest or exchange rates or securities prices. A futures contract on securities or currencies is an agreement to buy or sell securities or currencies during a designated month at whatever price exists at that time. A futures contract on a securities index does not involve the actual delivery of securities, but merely requires the payment of a cash settlement based on changes in the securities index. The Funds do not make payment or deliver securities upon entering into a futures contract. Instead, they put down a margin deposit, which is adjusted to reflect changes in the value of the contract and which remains in effect until the contract is terminated. The Funds may sell or purchase currency and other financial futures contracts. When a futures contract is sold by a Fund, the profit on the contract will tend to rise when the value of the underlying securities or currencies declines and to fall when the value of such securities or currencies increases. Thus, the Funds sell futures contracts in order to offset a possible decline in the profit on their securities or currencies. If a futures contract is purchased by a Fund, the value of the contract will tend to rise when the value of the underlying securities or currencies increases and to fall when the value or such securities or currencies declines. The Funds may enter into closing purchase and sale transactions in order to terminate a futures contract and may buy or sell put and call options for the purpose of closing out their options positions. The Funds' ability to enter into closing transactions depends on the development and maintenance of a liquid secondary market. There is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. As a result, there can be no assurance that the Funds will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Funds are not able to enter into an offsetting transaction, the Funds will continue to be required to maintain the margin deposits on the contract and to complete the contract according to its terms, in which case the Funds would continue to bear market risk on the transaction. RISK CHARACTERISTICS OF OPTIONS AND FUTURES Although options and futures transactions are intended to enable the Funds to manage market, exchange, or interest rate risks, these investment devices can be highly volatile, and the Funds' use of them can result in poorer performance (i.e., the Funds' returns may be reduced). The Funds' attempt to use such investment devices for hedging purposes may not be successful. Successful futures strategies require the ability to predict future movements in securities prices, interest rates and other economic factors. When the Funds use financial futures contracts and options on financial futures contracts as hedging devices, there is a risk that the prices of the securities subject to the financial futures contracts and options on financial futures contracts may not correlate perfectly with the prices of the securities in the Funds' portfolios. This may cause the financial futures contract and any related options to react to market changes differently than the portfolio securities. In addition, the Adviser could be incorrect in its expectations and forecasts about the direction or extent of market factors, such as interest rates, securities price movements, and other economic factors. Even if the Adviser correctly predicts interest rate movements, a hedge could be unsuccessful if changes in the value of a Fund's futures position did not correspond to changes in the value of its investments. In these events, the Funds may lose money on the financial futures contracts or the options on financial futures contracts. It is not certain that a secondary market for positions in financial futures contracts or for options on financial futures contracts will exist at all times. Although the Adviser will consider liquidity before entering into financial futures contracts or options on financial futures contracts transactions, there is no assurance that a liquid secondary market on an exchange will exist for any particular financial futures contract or option on a financial futures contract at any particular time. The Funds' ability to establish and close out financial futures contracts and options on financial futures contract positions depends on this secondary market. If a Fund is unable to close out its position due to disruptions in the market or lack of liquidity, the Fund may lose money on the futures contract or option, and the losses to the Fund could be significant. ZERO-COUPON AND STRIPPED SECURITIES The Fixed Income Fund may invest in zero-coupon and stripped securities. Zero- coupon securities in which the Fund may invest are debt obligations which are generally issued at a discount and payable in full at maturity, and which do not provide for current payments of interest prior to maturity. Zero-coupon securities usually trade at a deep discount from their face or par value and are subject to greater market value fluctuations from changing interest rates than debt obligations of comparable maturities which make current distributions of interest. As a result, the net asset value of shares of the Fixed Income Fund may fluctuate over a greater range than shares of other mutual funds investing in securities making current distributions of interest and having similar maturities. Zero-coupon securities may include U.S. Treasury bills issued directly by the U.S. Treasury or other short-term debt obligations, and longer-term bonds or notes and their unmatured interest coupons which have been separated by their holder, typically a custodian bank or investment banking firm. A number of securities firms and banks have stripped the interest coupons from the underlying principal (the "corpus") of U.S. Treasury securities and resold them in custodial receipt programs with a number of different names, including Treasury Income Growth Receipts ("TIGRS") and Certificates of Accrual on Treasuries ("CATS"). The underlying U.S. Treasury bonds and notes themselves are held in book-entry form at the Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered securities which are owned ostensibly by the bearer of holder thereof), in trust on behalf of the owners thereof. In addition, the Treasury has facilitated transfers of ownership of zero-coupon securities by accounting separately for the beneficial ownership of particular interest coupons and corpus payments on Treasury securities through the Federal Reserve book-entry record-keeping system. The Federal Reserve program as established by the Treasury Department is known as "STRIPS" or "Separate Trading of Registered Interest and Principal of Securities." Under the STRIPS program, the Fixed Income Fund will be able to have its beneficial ownership of U.S. Treasury zero-coupon securities recorded directly in the book-entry record-keeping system in lieu of having to hold certificates or other evidence of ownership of the underlying U.S. Treasury securities. When debt obligations have been stripped of their unmatured interest coupons by the holder, the stripped coupons are sold separately. The principal or corpus is sold at a deep discount because the buyer receives only the right to receive a future fixed payment on the security and does not receive any rights to periodic cash interest payments. Once stripped or separated, the corpus and coupons may be sold separately. Typically, the coupons are sold separately or grouped with other coupons with like maturity dates and sold in such bundled form. Purchasers of stripped obligations acquire, in effect, discount obligations that are economically identical to the zero-coupon securities issued directly by the obligor. FOREIGN INVESTMENTS The Fixed Income Fund may invest in foreign securities or securities denominated in or indexed to foreign currencies. In addition, the Fixed Income Fund may invest in foreign currencies. These may involve additional risks. Specifically, they may be affected by the strength of foreign currencies relative to the U.S. dollar, or by political or economic developments in foreign countries. Accounting procedures and government supervision may be less stringent than those applicable to U.S. companies. There may be less publicly available information about a foreign company than about a U.S. company. Foreign markets may be less liquid or more volatile than U.S. markets and may offer less protection to investors. It may also be more difficult to enforce contractual obligations abroad than would be the case in the United States because of differences in the legal systems. Foreign securities may be subject to foreign taxes, which may reduce yield, and may be less marketable than comparable U.S. securities. All these factors are considered by the Adviser before making any of these types of investments. RISK CHARACTERISTICS OF ASSET-BACKED SECURITIES The Fixed Income and U.S. Government Funds may invest in asset-backed securities. Asset-backed securities are created by the grouping of certain governmental, government-related and private loans, receivables and other lender assets into pools. Interests in these pools are sold as individual securities. Payments from the asset pools may be divided into several different tranches of debt securities, with some tranches entitled to receive regular installments of principal and interest, other tranches entitled to receive regular installments of interest, with principal payable at maturity or upon specified call dates, and other tranches only entitled to receive payments of principal and accrued interest at maturity or upon specified call dates. Different tranches of securities will bear different interest rates, which may be fixed or floating. Because the loans held in the asset pool often may be prepaid without penalty or premium, asset-backed securities and mortgage backed securities are generally subject to higher prepayment risks than most other types of debt instruments. Prepayment risks on mortgage securities tend to increase during periods of declining mortgage interest rates, because many borrowers refinance their mortgages to take advantage of the more favorable rates. Depending upon market conditions, the yield that the Fixed Income and U.S. Government Funds receive from the reinvestment of such prepayments, or any scheduled principal payments, may be lower than the yield on the original mortgage security. As a consequence, mortgage securities may be a less effective means of "locking in" interest rates than other types of debt securities having the same stated maturity and may also have less potential for capital appreciation. For certain types of asset pools, such as CMOs, prepayments may be allocated to one tranche of securities ahead of other tranches, in order to reduce the risk of prepayment for the other tranches. Prepayments may result in a capital loss to the Fixed Income and U.S. Government Funds to the extent that the prepaid mortgage securities were purchased at a market premium over their stated amount. Conversely, the prepayment of mortgage securities purchased at a market discount from their stated principal amount will accelerate the recognition of interest income by the Fixed Income and U.S. Government Funds which would be taxed as ordinary income when distributed to the shareholders. The credit characteristics of asset-backed securities also differ in a number of respects from those of traditional debt securities. The credit quality of most asset-backed securities depends primarily upon the credit quality of the assets underlying such securities, how well the entity issuing the securities is insulated from the credit risk of the originator or any other affiliated entities, and the amount and quality of any credit enhancement to such securities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies that have investment objectives and policies similar to its own. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) no Fund will own more than 3% of the total outstanding voting stock of any one investment company, (2) no Fund may invest more than 5% of its total assets in any one investment company and (3) no Fund may invest more than 10% of its total assets in investment companies in general. The Adviser will waive its investment advisory fee on assets invested in securities of other open-end investment companies. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one-third of the value of its total assets and pledge up to 15% (in the case of the Fixed Income and Managed Bond Funds), or one-third (in the case of U.S. Government Fund) of the value of those assets to secure such borrowings. RESTRICTED AND ILLIQUID SECURITIES The Funds may invest up to 10% of their net assets in securities which are subject to restrictions on resale under federal securities law. In the case of the Fixed Income and U.S. Government Funds, this restriction is not applicable to commercial paper issued under Section 4(2) of the Securities Act of 1933. The Fixed Income and Managed Bond Funds may invest up to 10% of their net assets in illiquid securities. The U.S. Government Fund may invest up to 15% of its net assets in illiquid securities. With respect to the Fixed Income, Managed Bond and U.S. Government Funds, illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non- negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. DIVERSIFICATION With respect to 75% of the value of its total assets, no Fund may invest more than 5% of its total assets in securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government securities) or own more than 10% of the outstanding voting securities of one issuer. SELLING SHORT The Fixed Income and Managed Bond Funds will not make short sales of securities, except in certain limited circumstances. Certain of the Funds have adopted the following investment limitations, which may be changed by the Trustees without shareholder approval. NEW ISSUERS The Managed Bond Fund will not invest more than 5% of the value of its total assets in securities of issuers (or guarantors, where applicable) which have records of less than three years of continuous operations, including the operation of any predecessor. WARRANTS The Fixed Income and Managed Bond Funds may not invest more than 5% of their net assets in warrants. No more than 2% of this 5% may be in warrants which are not listed on the New York or American Stock Exchanges. SHAREHOLDER - ------------------------ ------------------------ - ------------------------ ------------------------ GUIDE SHARE PRICE CALCULATION In the case of no-load Funds, the net asset value, the market price and the offering price of Shares are all the same. Purchases, redemptions, and exchanges are made at net asset value. The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of Shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Y Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yield of Y Shares is calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Y Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return and yield will be calculated separately for Y Shares, Class A Shares, Class B Shares and Class C Shares of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee, and Class B Shares and Class C Shares are subject to a Rule 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the contingent deferred sales charge ("CDSC"), which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO - ------------------------- ------------------------- - ------------------------- ------------------------- BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There are no sales charges imposed on Y Shares of the Funds. However, there is a $1,000 minimum initial investment requirement which may be waived incertain situations. For further information, please contact the Capital Management Group of First Union at1- 800-326-2584. Subsequent investments may be in any amounts. BY TELEPHONE You may purchase Y Shares by telephone from the Capital Management Group of First Union at 1-800-326-2584. (Texas residents should directly contact the Mutual Funds Group of First Union Brokerage Services, Inc. at 1-800-326-3241.) Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. Purchase orders must be received by 4:00 p.m. (Eastern time). Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT FROM ONE - ------------------------- ------------------------- - ------------------------- ------------------------- FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call First Union at 1-800-326-2584 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Y Shares of one First Union Fund for Y Shares of any other First Union Fund by calling toll free 1-800-326-2584 or by writing to First Union. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO - ------------------------- ------------------------- - ------------------------- ------------------------- REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any fees. You may redeem Shares in person or by telephoning First Union at 1-800-326-2584 or by written request to First Union. There is no redemption fee charged. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. MANAGEMENT OF FIRST - ------------------------- ------------------------- - ------------------------- ------------------------- UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. Thomas L. Ellis is a Vice President of First Union National Bank of North Carolina, N.A. Prior to joining First Union in 1985, Mr. Ellis had seventeen years of investment management and sales experience, including eleven years marketing short and medium-term obligations to institutional investors, plus three years as head trader for First Boston Corporation. Mr. Ellis has managed the Fixed Income Fund since its inception in July 1988. Glen T. Insley is a Senior Vice President and Director of Fixed Income Portfolio Management for First Union National Bank of North Carolina, N.A. Mr. Insley served as Director of Fixed Income Management at One Federal Asset Management, a subsidiary of Shawmut Bank, for six years prior to joining First Union. Mr. Insley has served as the portfolio manager for the Managed Bond Fund since May 1993. Rollin C. Williams is a Vice President of First Union National Bank of North Carolina, N.A. and has over 24 years of investment management experience. Mr. Williams was the Head of Fixed Income Investments at Dominion Trust Company from 1988 until its acquisition by First Union Corporation. Mr. Williams has served as the portfolio manager for the U.S. Government Fund since its inception in December 1992. FUND ADMINISTRATION Federated Securities Corp., Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES - ------------------------- ------------------------- - ------------------------- ------------------------- Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.50 of 1% of each of the Income Funds' average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Administrative Fee Net Assets of the Trust ------------------ ----------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND Y SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal, and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND - ------------------------- ------------------------- - ------------------------- ------------------------- PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities, for numerous accounts, was the owner of record of 32,878,796 shares (92.54%), 8,511,525 shares (91.53%), and 1,373,452 shares (81.21%), respectively, of Fixed Income Fund--Y Shares, Managed Bond Fund--Y Shares, and U.S. Government Fund--Y Shares; and First Union Brokerage Services ("FUBS"), for the exclusive benefit of Merle Adair Connell Trust, Winter Garden, Florida, for the exclusive benefit of Helen G. Bender, Wildwood, Florida, and acting in various capacities for numerous accounts was the owner of record of 10,834 shares (36.90%) and 11,037 shares (37.59%), respectively, of the U.S. Government Fund--Class C Investment Shares, and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required, by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS - ------------------------- ------------------------- - ------------------------- ------------------------- AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid monthly for the Fixed Income and Managed Bond Funds, and dividends are declared daily and paid monthly for the U.S. Government Fund. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or First Union in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX - ------------------------- ------------------------- - ------------------------- ------------------------- INFORMATION Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. All shareholders, unless otherwise exempt, are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES - ------------------------- ------------------------- - ------------------------- ------------------------- OF SHARES First Union Fixed Income Funds, except for First Union Managed Bond Portfolio, offer four classes of shares: Y Shares for institutional investors, and Class A Shares, Class B Shares and Class C Shares for individuals and other customers of First Union. Class A Shares, Class B Shares and Class C Shares are sold to customers of First Union and others at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B Shares and Class C Shares). Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non-qualified employee benefit and savings plans which make Shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount up to 0.50 of 1% of the net asset value of the Class A Shares purchased. These payments are subject to reclaim in the event the Class A Shares are redeemed within 12 months after purchase. Class A Shares, Class B Shares and Class C Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of 0.25 of 1% for Class A Shares and 0.75 of 1% for Class B Shares and Class C Shares of each Fund's average daily net asset value. In addition, Class B Shares and Class C Shares pay a shareholder services fee of 0.25 of 1% of the respective class's average daily net assets. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares, and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either contact the Capital Management Group of First Union at 1-800-326-2584, or write the Trust. ADDRESSES - ------------------------- ------------------------- - ------------------------- ------------------------- - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] Federated Securities Corp., Distributor 535671 (10/pkg.) G00850-06 (2/95) PROSPECTUS FIRST UNION INCOME FUNDS CLASS A, B AND C INVESTMENT SHARES FEBRUARY 28, 1995 FIRST UNION INCOME FUNDS Portfolios of First Union Funds - ------------------------ ------------------------ - ------------------------ ------------------------ CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes three diversified Income Funds, three diversified Growth and Income Funds two diversified Growth Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Income Funds .First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Growth and Income Funds .First Union Balanced Portfolio; .First Union Utility Portfolio; and .First Union Value Portfolio. Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Money Market Funds .First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and .First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares") and Class C Investment Shares ("Class C Shares") (collectively referred to as "Investment Shares") of First Union Income Funds. It concisely describes the information which you should know before investing in Class A Shares, Class B Shares or Class C Shares of any of the First Union Income Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Income Fund in its Statement of Additional Information dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-3241. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - -------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF - ------------------------- ------------------------- - ------------------------- ------------------------- CONTENTS Summary 2 How to Redeem Shares 24 - -------------------------------------- -------------------------------------- Summary of Fund Expenses 4 Additional Shareholder Services 25 - -------------------------------------- -------------------------------------- Financial Highlights 7 Management of First Union Funds 25 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 12 Fees and Expenses 27 - -------------------------------------- -------------------------------------- First Union Fixed Income Portfolio 12 Shareholder Rights and Privileges 28 - -------------------------------------- -------------------------------------- First Union U.S. Government Distributions and Taxes 29 Portfolio 13 -------------------------------------- - -------------------------------------- Tax Information 29 Other Investment Policies 14 -------------------------------------- - -------------------------------------- Other Classes of Shares 30 Shareholder Guide 19 -------------------------------------- - -------------------------------------- Shareholder Reports 30 How to Buy Shares 21 -------------------------------------- - -------------------------------------- Addresses 31 How to Convert Your Investment from -------------------------------------- One First Union Fund to Another First Union Fund 23 - -------------------------------------- SUMMARY - ------------------------- ------------------------- - ------------------------- ------------------------- DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Income Fund, except First Union Managed Bond Portfolio, is divided into four classes of shares: Class A Shares, Class B Shares, Class C Shares and Y Shares. Class A Shares, Class B Shares and Class C Shares are sold to individuals and other customers of First Union (the "Adviser") and are sold at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B and Class C Shares). Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). First Union Managed Bond Portfolio presently offers only Y Shares. This prospectus relates to all three classes of Investment Shares ("Shares") of First Union Fixed Income Portfolio and First Union U.S. Government Portfolio (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Class A Shares, Class B Shares, and Class C Shares are offered in the following two Funds: . First Union Fixed Income Portfolio ("Fixed Income Fund")--seeks to provide a high level of current income by investing in a broad range of investment grade debt securities, with capital growth as a secondary objective; and . First Union U.S. Government Portfolio ("U.S. Government Fund")--seeks a high level of current income consistent with stability of principal. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Class A, Class B and Class C Shares of either of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The market value of fixed income securities, which constitute a major part of the investments of the Funds described in this prospectus, may vary inversely in response to changes in prevailing interest rates. The foreign securities in which the Fixed Income Fund may invest may be subject to certain risks in addition to those inherent in U.S. investments. One or both Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, lending portfolio securities and entering into futures contracts and related options as hedges. These risks and those associated with investing in mortgage-backed securities, when-issued securities, options and variable rate securities are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION INCOME FUNDS CLASS A SHARES Fixed U.S. Income Government Fund Fund ------ ---------- Class A Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)............................................. 4.75% 4.75% Maximum Sales Load Imposed on Reinvested Dividends (as a per- centage of offering price).................................. None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable).............................................. None None Redemption Fees (as a percentage of amount redeemed, if ap- plicable)................................................... None None Exchange Fee................................................. None None Annual Class A Shares Operating Expenses (As a percentage of average net assets) Management Fee............................................... 0.50% 0.50% 12b-1 Fees (1)............................................... 0.10% 0.25% Total Other Expenses......................................... 0.15% 0.27% Total Class A Shares Operating Expenses (2)................ 0.75% 1.02% (1) The Class A Shares can pay up to 0.75 of 1% of Class A Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, Fixed Income Fund plans to limit the Class A Shares' 12b-1 payments to 0.10 of 1% of Class A Shares' average daily net assets. U.S. Government Fund plans to limit the Class A Shares' 12b-1 payments to 0.25 of 1% of Class A Shares' average daily net assets. (2) U.S. Government Fund's Class A Shares Annual Operating Expenses were 0.96% for the year ended December 31, 1994. Total Class A Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser, were 1.00% for the year ended December 31, 1994. The Annual Class A Shares Operating Expenses for U.S. Government Fund in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period; and (3) payment of maximum sales load. The Funds charge no redemption fees for Class A Shares. Fixed Income Fund........................... $55 $70 $ 87 $136 U.S. Government Fund........................ $57 $78 $101 $166
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class A Shares of the Funds. The Funds also offer three additional classes of shares called Y Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. Y Shares, Class B Shares and Class C Shares bear no front-end sales load. See "Other Classes of Shares."
SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION INCOME FUNDS CLASS B SHARES Fixed U.S. Income Government Fund Fund ----------------------------- ----------------------------- Class B Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a per- 5% during the first year, 5% during the first year, centage of original 4% during the second year, 4% during the second year, purchase price or re- 3% during the third year, 3% during the third year, demption proceeds, as 3% during the fourth year, 3% during the fourth year, applicable) (1)........ 2% during the fifth year, 2% during the fifth year, 1% during the sixth year, 1% during the sixth year, 1% during the seventh year, 1% during the seventh year, and 0% after the seventh year and 0% after the seventh year Redemption Fees (as a percentage of amount redeemed, if applicable)......... None None Exchange Fee............ None None Annual Class B Shares Operating Expenses (As a percentage of average net assets) Management Fee.......... 0.50% 0.50% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses.... 0.40% 0.52% Shareholder Service Fee (2)............. 0.25% 0.25% Total Class B Shares Operating Expenses (3)................. 1.65% 1.77%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than seven years prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per share. (2) The Funds began accruing Shareholder Service Fees in September, 1994 at the maximum rate of 0.25%. Shareholder Service Fees for Fixed Income Fund and U.S. Government Fund amounted to 0.10% and 0.08%, respectively, for the fiscal year ended December 31, 1994. (3) U.S. Government Fund's Total Class B Shares Annual Operating Expenses were 1.54% for the year ended December 31, 1994. Total Class B Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser, were 1.58% for the year ended December 31, 1994. The Annual Class B Shares Operating Expenses for U.S. Government Fund in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period: Fixed Income Fund.................................................................. $68 $85 $113 $195 U.S. Government Fund............................................................... $70 $89 $119 $208 You would pay the following expenses on the same investment, assuming no redemptions: Fixed Income Fund.................................................................. $17 $52 $ 90 $195 U.S. Government Fund............................................................... $18 $56 $ 96 $208
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class B Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class A Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load or 12b-1 fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales load of 4.75%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares."
SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION INCOME FUNDS CLASS C SHARES Fixed U.S. Income Government Fund Fund --------------------------- --------------------------- Class C Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a per- centage of original purchase price or redemption proceeds, 1% during the first year, 1% during the first year, as applicable) (1)..... and 0% after the first year and 0% after the first year Redemption Fee (as a percentage of amount redeemed, if applicable)......... None None Exchange Fee............ None None Annual Class C Shares Projected Operating Expenses* (As a percentage of projected average net assets) Management Fee.......... 0.50% 0.50% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses.... 0.40% 0.52% Shareholder Service Fee.................... 0.25% 0.25% Total Class C Shares Operating Expenses (2). 1.65% 1.77%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than one year prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per share. (2) U.S. Government Fund's Total Class C Shares Annual Operating Expenses were 1.71% for the period from September 2, 1994, (commencement of operations) to December 31, 1994. Total Class C Operating Expense for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser, would have been 1.75%. The Annual Class C Shares Operating Expenses for U.S. Government Fund, in the table above, are based on expenses expected during the fiscal year ending December 31, 1995. * Expenses in this table are estimates based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. Fixed Income Fund............................................ $27 $52 U.S. Government Fund......................................... $28 $56 You would pay the following expenses on the same investment, assuming no redemptions: Fixed Income Fund............................................ $17 $52 U.S. Government Fund......................................... $18 $56
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class C Shares of the Funds. The Funds also offer three additional classes of shares called Y Shares, Class A Shares and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load or 12b-1 fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales load of 4.75%. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales load. See "Other Classes of Shares." FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Class A Investment Shares ----------------------------------------------- Year Ended Year Ended December 31, March 31, ----------------------------------------------- --------------- 1994 1993 1992 1991 1990* 1990 1989** - ------------------------ ------- ------- ------- ------- ------- ------ ------- Net asset value, begin- ning of period $10.42 $10.41 $10.54 $ 9.99 $ 9.72 $ 9.50 $ 9.70 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.65 0.65 0.71 0.73 0.55 0.79 0.10 - ------------------------ Net realized and unrealized gain (loss) on (0.91) 0.19 (0.06) 0.60 0.24 0.20 (0.14) investments ------ ----- ------ ----- ----- ----- ------ - ------------------------ Total from investment operations (0.26) 0.84 0.65 1.33 0.79 0.99 (0.04) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.64) (0.65) (0.67) (0.70) (0.52) (0.77) (0.16) - ------------------------ Distributions to share- holders from net realized gain on in- vestment transactions -- (0.18) (0.11) (0.07) -- -- -- - ------------------------ Distributions in excess of net investment in- come -- -- -- (0.01)(c) -- -- -- - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total distributions (0.64) (0.83) (0.78) (0.78) (0.52) (0.77) (0.16) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.52 $10.42 $10.41 $10.54 $ 9.99 $ 9.72 $ 9.50 - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total return+ (2.57%) 8.29% 6.39% 13.74% 8.31% 10.51% (0.31%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.75% 0.93% 0.90% 0.80% 1.01%(b) 1.00% 1.78%(b) - ------------------------ Net investment income 6.46% 6.15% 6.79% 7.30% 7.53%(b) 7.57% 6.10%(b) - ------------------------ Expense waiver/reimbursement (a) -- -- -- 0.09% 0.81%(b) 0.50% -- - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $19,127 $22,865 $21,488 $17,680 $11,765 $6,496 $11,580 - ------------------------ Portfolio turnover rate 48% 73% 66% 53% 27% 32% 18% - ------------------------
* Nine months ended December 31, 1990. ** Reflects operations for the period from January 28, 1989 (commencement of operations) to March 31, 1989. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the year ended December 31, 1991 were a result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Class B Class C Investment Investment Shares Shares ---------------- ------------ Year Ended Year Ended December 31, December 31, ---------------- ------------ 1994 1993* 1994** - ------------------------------------------- -------- ------ ------------ Net asset value, beginning of period $10.44 $10.57 $ 9.85 - ------------------------------------------- Income from investment operations - ------------------------------------------- Net investment income 0.58 0.58 0.18 - ------------------------------------------- Net realized and unrealized gain (loss) on investments (0.92) 0.05 (0.30) - ------------------------------------------- ------ ------ ------ Total from investment operations (0.34) 0.63 (0.12) - ------------------------------------------- Less distributions - ------------------------------------------- Dividends to shareholders from net invest- ment income (0.56) (0.58) (0.18) - ------------------------------------------- Dividends to shareholders from net real- ized gain on investment transactions -- (0.18) -- - ------------------------------------------- ------ ------ ------ Total distributions (0.56) (0.76) (0.18) - ------------------------------------------- ------ ------ ------ Net asset value, end of period $ 9.54 $10.44 $ 9.55 - ------------------------------------------- ------ ------ ------ Total return+ (3.33%) 6.08% (1.27%) - ------------------------------------------- Ratios to Average Net Assets - ------------------------------------------- Expenses 1.50% 1.57%(a) 1.65%(a) - ------------------------------------------- Net investment income 5.75% 5.42%(a) 5.87%(a) - ------------------------------------------- Supplemental Data - ------------------------------------------- Net assets, end of period (000 omitted) $17,625 $8,876 $512 - ------------------------------------------- Portfolio turnover rate 48% 73% 48% - -------------------------------------------
* Reflects operations for the period from January 25, 1993, (commencement of operations) to December 31, 1993. ** Reflects operations for the period from September 2, 1994, (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994 which can be obtained free of charge. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Fixed Income Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Y Shares ------------------------------------ Year Ended December 31, ------------------------------------ 1994 1993 1992 1991* - ------------------------------------ -------- -------- -------- -------- Net asset value, beginning of period $10.43 $10.41 $10.54 $10.06 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.65 0.69 0.70 0.71 - ------------------------------------ Net realized and unrealized gain (loss) on investments (0.91) 0.19 (0.02) 0.56 - ------------------------------------ ------ ------ ------ ------ Total from investment operations (0.26) 0.88 0.68 1.27 - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.65) (0.68) (0.70) (0.71) - ------------------------------------ Distributions to shareholders from net realized gain on investment transactions -- (0.18) (0.11) (0.07) - ------------------------------------ Distributions in excess of net in- vestment income -- -- -- (0.01)(c) - ------------------------------------ ------ ------ ------ ------ Total distributions (0.65) (0.86) (0.81) (0.79) - ------------------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.52 $10.43 $10.41 $10.54 - ------------------------------------ ------ ------ ------ ------ Total return+ (2.55%) 8.67% 6.64% 13.80% - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.65% 0.66% 0.69% 0.69%(b) - ------------------------------------ Net investment income 6.56% 6.41% 6.67% 7.12%(b) - ------------------------------------ Expense waiver/reimbursement (a) -- -- -- 0.07%(b) - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $345,025 $376,445 $324,068 $256,254 - ------------------------------------ Portfolio turnover rate 48% 73% 66% 55% - ------------------------------------
* Reflects operations for the period from January 4, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the year ended December 31, 1991 were a result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union U.S. Government Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Shares Shares Shares Y Shares ------------------ -------------------- ------------ ----------------- Year Ended Year Ended Year Ended Year Ended December 31, December 31, December 31, December 31, ------------------ -------------------- ------------ ----------------- 1994 1993* 1994 1993* 1994** 1994 1993*** - ------------------------ ------- -------- ---------- --------- ------------ ------- ------- Net asset value, begin- ning of period $10.05 $10.00 $10.05 $10.00 $9.39 $10.05 $10.25 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.66 0.68 0.61 0.63 0.20 0.69 0.25 - ------------------------ Net realized and unrealized gain (loss) on investments (0.98) 0.05 (0.98) 0.05 (0.32) (0.98) (0.20) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations (0.32) 0.73 (0.37) 0.68 (0.12) (0.29) 0.05 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.66) (0.68) (0.61) (0.63) (0.20) (0.69) (0.25) - ------------------------ ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.07 $10.05 $ 9.07 $10.05 $9.07 $ 9.07 $10.05 - ------------------------ ------ ------ ------ ------ ------ ------ ------ Total return+ (3.18%) 7.43% (3.75%) 6.91% (1.30%) (2.94%) 0.49% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.96% 0.68%(b) 1.54% 1.19%(b) 1.71%(b) 0.71% 0.48%(b) - ------------------------ Net investment income 6.97% 6.93%(b) 6.42% 6.44%(b) 6.70%(b) 7.27% 7.20%(b) - ------------------------ Expense waiver/reimbursement (a) 0.04% 0.31%(b) 0.04% 0.31%(b) 0.04%(b) 0.04% 0.31%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $23,706 $38,851 $195,571 $236,696 $266 $15,595 $14,486 - ------------------------ Portfolio turnover rate 19% 39% 19% 39% 19% 19% 39% - ------------------------
* Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. *** Reflects operations for the period from September 2, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994 which can be obtained free of charge. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Managed Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Income Funds' Annual Report, which may be obtained from the Fund.
Y Shares (a) ------------------------------------ Year Ended December 31, ------------------------------------ 1994 1993 1992 1991* - ------------------------------------ ------- -------- -------- -------- Net asset value, beginning of period $10.46 $10.34 $10.60 $10.00 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.66 0.65 0.66 0.49 - ------------------------------------ Net realized and unrealized gain (loss) on investments (1.11) 0.43 (0.08) 0.63 - ------------------------------------ ------ ------ ------ ------ Total from investment operations (0.45) 1.08 0.58 1.12 - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.66) (0.65) (0.66) (0.49) - ------------------------------------ Distributions to shareholders from net realized gain on investment transactions (0.00) (0.31) (0.18) (0.03) - ------------------------------------ ------ ------ ------ ------ Total distributions (0.66) (0.96) (0.84) (0.52) - ------------------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.35 $10.46 $10.34 $10.60 - ------------------------------------ ------ ------ ------ ------ Total return+ (4.40%) 10.59% 5.65% 11.63% - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.70% 0.70% 0.70% 0.70%(c) - ------------------------------------ Net investment income 6.68% 6.02% 6.30% 6.57%(c) - ------------------------------------ Expense waiver/reimbursement (b) 0.01% 0.03% 0.05% 0.00% - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $90,318 $109,067 $121,655 $112,984 - ------------------------------------ Portfolio turnover rate 32% 53% 56% 17% - ------------------------------------
* Reflects operations for the period from April 1, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Class A, Class B, and Class C Investment Shares were not being offered as of December 31, 1994. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Y Shares. (b) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES - ------------------------- ------------------------- - ------------------------- ------------------------- AND POLICIES First Union Income Funds provide a broad range of objectives and policies, intended to offer investment alternatives to a large group of investors with a wide range of investment objectives. The investment objectives and policies of each Fund are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION FIXED INCOME - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: High level of current income with capital growth as a secondary objective. Invests in: A broad range of investment grade debt securities. Suitable for: Conservative investors who want attractive income. Key Benefit: Investors can participate in a broad portfolio of fixed income securities rather than purchasing a single issue. DESCRIPTION OF THE FUND The Fixed Income Fund seeks to provide a high level of current income by investing primarily in a broad range of investment grade debt securities. Capital growth is a secondary objective. The Fund will normally invest at least 80% of its assets in debt securities. At least 65% of the value of the portfolio will be invested in fixed income securities. TYPES OF INVESTMENTS While the Fund may invest in securities rated BBB by Standard & Poor's Ratings Group ("S&P") or Baa by Moody's Investors Service, Inc. ("Moody's"), the Adviser currently intends to limit the Fund's investments to securities rated A or higher by Moody's or S&P, or which, if unrated, are considered to be of comparable quality by the Adviser. Debt securities may include fixed, adjustable rate, zero coupon, or stripped securities, debentures, notes, U.S. government securities, and debt securities convertible into, or exchangeable for, preferred or common stock. Debt securities may also include mortgage-backed and asset-backed securities (which are more fully described under "First Union U.S. Government Portfolio--Types of Investments"). Stated final maturity for these securities may range up to 30 years. The duration of the securities will not exceed 10 years. The Fund intends to maintain a dollar-weighted average maturity of 5 years or less. Market-expected average life will be used for certain types of issues in computing the average maturity. In normal market conditions the Fund may invest up to 20% of its assets in money market instruments consisting of: (1) high grade commercial paper, including master demand notes; (2) obligations of banks or savings and loan associations having at least $1 billion in deposits, including certificates of deposit and bankers' acceptances; (3) A-rated or better corporate obligations; (4) obligations issued or guaranteed by the U.S. government or by any agency or instrumentality of the U.S. government; and (5) repurchase agreements collateralized by any security listed above. The types of U.S. government securities in which the Fund may invest include: direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes, and bonds; and notes, bonds, and discount notes of U.S. government agencies or instrumentalities, such as the: Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks, and Banks for Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal Home Loan Mortgage Corporation; Federal National Mortgage Association; Government National Mortgage Association; Student Loan Marketing Association; Tennessee Valley Authority; Export-Import Bank of the United States; Commodity Credit Corporation; Federal Financing Bank; and National Credit Union Administration (collectively, "U.S. government securities"). Some U.S. government agency obligations are backed by the full faith and credit of the U.S. Treasury. Others in which the Fund may invest are supported by: the issuer's right to borrow an amount limited to a specific line of credit from the U.S. Treasury; discretionary authority of the U.S. government to purchase certain obligations of an agency or instrumentality; or the credit of the agency or instrumentality. The Fund may also invest up to 20% of its assets in foreign securities (either foreign or U.S. securities traded in foreign markets) in order to provide further diversification. The Fund may also invest in preferred stock; units which are debt securities with stock or warrants attached; and obligations denominated in foreign currencies. In making these decisions, the Adviser will consider such factors as the condition and growth potential of various economies and securities markets, currency and taxation considerations and other pertinent financial, social, national and political factors. (See "Other Investment Policies" and "Foreign Investments.") The Fund may elect to use options and financial futures for hedging purposes as described in "Other Investment Policies--Options and Futures" and in the Fund's Statement of Additional Information. The Fund may also elect to use currency exchange contracts to manage exchange rate risk in order to stabilize the U.S. dollar value of a security that it has agreed to buy or sell. The Fund will not invest in securities judged to be speculative or of poor quality. TEMPORARY INVESTMENTS For temporary defensive purposes, the Fund may invest up to 100% of its assets in the money market instruments listed above. FIRST UNION U.S. GOVERNMENT - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: High level of current income consistent with stability of principal. Invests in: Debt instruments issued or guaranteed by the U.S. government, its agencies, or instrumentalities. Suitable for: Conservative investors seeking high current yields plus relative safety. Key Benefit: Active management of a blend of securities and maturities to maximize the opportunities and minimize the risks created by changing interest rates. DESCRIPTION OF THE FUND The U.S. Government Fund seeks a high level of current income consistent with stability of principal. The Fund seeks to achieve this objective by investing primarily in debt instruments which are U.S. government securities, its agencies or instrumentalities as such term is defined under "First Union Fixed Income Portfolio--Types of Investments.") As a matter of policy, the Fund will invest at least 65% of the value of its total assets in such U.S. government securities. TYPES OF INVESTMENTS In addition to U.S. government securities, the Fund may invest in: Securities representing ownership interests in mortgage pools ("mortgage- backed securities"). The yield and maturity characteristics of mortgage- backed securities correspond to those of the underlying mortgages, with interest and principal payments (including prepayments (i.e. paying remaining principal before the mortgage's scheduled maturity) passed through to the holder of the mortgage-backed securities. The yield and price of mortgage-backed securities will be affected by prepayments which substantially shorten effective maturities. Thus, during periods of declining interest rates, prepayments may be expected to increase, requiring the Fund to reinvest the proceeds at lower interest rates, making it difficult to effectively lock in high interest rates. Conversely, mortgage-backed securities may experience less pronounced declines in value during periods of rising interest rates; Securities representing ownership interests in a pool of assets ("asset- backed securities"), for which automobile and credit card receivables are the most common collateral. Because much of the underlying collateral is unsecured, asset-backed securities are structured to include additional collateral and/or additional credit support to protect against default. The Adviser evaluates the strength of each particular issue of asset-backed security, taking into account the structure of the issue and its credit support. (See "Risk Characteristics of Asset-Backed Securities."); Collateralized mortgage obligations ("CMOs") issued by single-purpose, stand-alone entities. A CMO is a mortgage-backed security that manages the risk of repayment by separating mortgage pools into short, medium and long- term portions. These portions are generally retired in sequence as the underlying mortgage loans in the mortgage pool are repaid. Similarly, as prepayments are made, the portion of CMO first to mature will be retired prior to its maturity, thus having the same effect as the prepayment of mortgages underlying a mortgage-backed security. The issuer of a series of CMOs may elect to be treated as a Real Estate Mortgage Investment Conduit (a "REMIC"), which has certain special tax attributes.The Fund will invest only in CMOs which are rated AAA by a nationally recognized statistical rating organization and which may be: (a) collateralized by pools of mortgages in which each mortgage is guaranteed as to payment of principal and interest by an agency or instrumentality of the U.S. government; (b) collateralized by pools of mortgages in which payment of principal and interest is guaranteed by the issuer and such guarantee is collateralized by U.S. government securities; or (c) securities in which the proceeds of the issuance are invested in mortgage securities and payment of the principal and interest are supported by the credit of an agency or instrumentality of the U.S. government. The Fund may invest up to 20% of its total assets in CMOs; Commercial paper which matures in 270 days or less so long as at least two of its ratings are high quality ratings by nationally recognized statistical rating organizations. Such ratings would include: A-1 or A-2 by S&P, Prime-1 or Prime-2 by Moody's, or F-1 or F-2 by Fitch Investors Service; Bonds and other debt securities rated Baa or higher by Moody's or BBB or higher by S&P, or which, if unrated, are considered to be of comparable quality by the Adviser; Securities of other investment companies; and Repurchase agreements collateralized by eligible investments. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. TEMPORARY INVESTMENTS During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, the Fund may temporarily invest up to 100% of its assets in cash and cash items including such short-term obligations as: commercial paper; U.S. government securities; and repurchase agreements collateralized by eligible investments. OTHER INVESTMENT - ------------------------- ------------------------- - ------------------------- ------------------------- POLICIES The Funds have adopted the following practices for specific types of investments. DOWNGRADES If any security invested in by either of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Fund's risk is the inability of the seller to pay the agreed-upon price on delivery date. However, this risk is tempered by the ability of the Fund to sell the security in the open market in the case of a default. In such a case, the Fund may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which a Fund purchases securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause a Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, a Fund may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. Government Securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, the Funds will not lend any of their assets except portfolio securities up to 15% (in the case of the Fixed Income Fund) or one-third (in the case of the U.S. Government Fund) of the value of their total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. OPTIONS AND FUTURES The Funds may engage in options and futures transactions. Options and futures transactions are intended to enable a Fund to manage market, interest rate or exchange rate risk, and the Funds do not use these transactions for speculation or leverage. The Funds may attempt to hedge all or a portion of their portfolios through the purchase of both put and call options on their portfolio securities and listed put options on financial futures contracts for portfolio securities. The Funds may also write covered call options on their portfolio securities to attempt to increase their current income. The Funds will maintain their positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. The Funds may purchase listed put options on financial futures contracts. These options will be used only to protect portfolio securities against decreases in value resulting from market factors such as an anticipated increase in interest rates. The Funds may write (i.e., sell) covered call and put options. By writing a call option, a Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price. By writing a put option, a Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. The Funds also may write straddles (combinations of covered puts and calls on the same underlying security). The Funds may only write "covered" options. This means that so long as a Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. A Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of the put option, it deposits and maintains with its custodian in a segregated account liquid assets having a value equal to or greater than the exercise price of the option. The principal reason for writing call or put options is to obtain, through a receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Funds receive a premium from writing a call or put option which they retain whether or not the option is exercised. By writing a call option, the Funds might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Funds might become obligated to purchase the underlying securities for more than their current market price upon exercise. A futures contract is a firm commitment by two parties: the seller, who agrees to make delivery of the specific type of instrument called for in the contract ("going short"), and the buyer, who agrees to take delivery of the instrument ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt instruments issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. If a Fund would enter into financial futures contracts directly to hedge its holdings of fixed income securities, it would enter into contracts to deliver securities at an undetermined price (i.e., "go short") to protect itself against the possibility that the prices of its fixed income securities may decline during the Fund's anticipated holding period. A Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. The Funds may also enter into currency and other financial futures contracts and write options on such contracts. The Funds intend to enter into such contracts and related options for hedging purposes. The Funds will enter into futures on securities, currencies, or index-based futures contracts in order to hedge against changes in interest or exchange rates or securities prices. A futures contract on securities or currencies is an agreement to buy or sell securities or currencies during a designated month at whatever price exists at that time. A futures contract on a securities index does not involve the actual delivery of securities, but merely requires the payment of a cash settlement based on changes in the securities index. The Funds do not make payment or deliver securities upon entering into a futures contract. Instead, they put down a margin deposit, which is adjusted to reflect changes in the value of the contract and which remains in effect until the contract is terminated. The Funds may sell or purchase currency and other financial futures contracts. When a futures contract is sold by a Fund, the profit on the contract will tend to rise when the value of the underlying securities or currencies declines and to fall when the value of such securities or currencies increases. Thus, the Funds sell futures contracts in order to offset a possible decline in the profit on their securities or currencies. If a futures contract is purchased by a Fund, the value of the contract will tend to rise when the value of the underlying securities or currencies increases and to fall when the value of such securities or currencies declines. The Funds may enter into closing purchase and sale transactions in order to terminate a futures contract and may buy or sell put and call options for the purpose of closing out their options positions. The Funds' ability to enter into closing transactions depends on the development and maintenance of a liquid secondary market. There is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. As a result, there can be no assurance that the Funds will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Funds are not able to enter into an offsetting transaction, the Funds will continue to be required to maintain the margin deposits on the contract and to complete the contract according to its terms, in which case the Funds would continue to bear market risk on the transaction. RISK CHARACTERISTICS OF OPTIONS AND FUTURES Although options and futures transactions are intended to enable the Funds to manage market, exchange, or interest rate risks, these investment devices can be highly volatile, and the Funds' use of them can result in poorer performance (i.e., the Funds' returns may be reduced). The Funds' attempt to use such investment devices for hedging purposes may not be successful. Successful futures strategies require the ability to predict future movements in securities prices, interest rates and other economic factors. When the Funds use financial futures contracts and options on financial futures contracts as hedging devices, there is a risk that the prices of the securities subject to the financial futures contracts and options on financial futures contracts may not correlate perfectly with the prices of the securities in the Funds' portfolios. This may cause the financial futures contract and any related options to react to market changes differently than the portfolio securities. In addition, the Adviser could be incorrect in its expectations and forecasts about the direction or extent of market factors, such as interest rates, securities price movements, and other economic factors. Even if the Adviser correctly predicts interest rate movements, a hedge could be unsuccessful if changes in the value of a Fund's futures position did not correspond to changes in the value of its investments. In these events, the Funds may lose money on the financial futures contracts or the options on financial futures contracts. It is not certain that a secondary market for positions in financial futures contracts or for options on financial futures contracts will exist at all times. Although the Adviser will consider liquidity before entering into financial futures contracts or options on financial futures contracts transactions, there is no assurance that a liquid secondary market on an exchange will exist for any particular financial futures contract or option on a financial futures contract at any particular time. The Funds' ability to establish and close out financial futures contracts and options on financial futures contract positions depends on this secondary market. If a Fund is unable to close out its position due to disruptions in the market or lack of liquidity, the Fund may lose money on the futures contract or option, and the losses to the Fund could be significant. ZERO-COUPON AND STRIPPED SECURITIES The Fixed Income Fund may invest in zero-coupon and stripped securities. Zero- coupon securities in which the Fund may invest are debt obligations which are generally issued at a discount and payable in full at maturity, and which do not provide for current payments of interest prior to maturity. Zero-coupon securities usually trade at a deep discount from their face or par value and are subject to greater market value fluctuations from changing interest rates then debt obligations of comparable maturities which make current distributions of interest. As a result, the net asset value of shares of the Fixed Income Fund may fluctuate over a greater range than shares of other mutual funds investing in securities making current distributions of interest and having similar maturities. Zero-coupon securities may include U.S. Treasury bills issued directly by the U.S. Treasury or other short-term debt obligations, and longer-term bonds or notes and their unmatured interest coupons which have been separated by their holder, typically a custodian bank or investment banking firm. A number of securities firms and banks have stripped the interest coupons from the underlying principal (the "corpus") of U.S. Treasury securities and resold them in custodial receipt programs with a number of different names, including Treasury Income Growth Receipts ("TIGRS") and Certificates of Accrual on Treasuries ("CATS"). The underlying U.S. Treasury bonds and notes themselves are hold in book-entry form at the Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered securities which are owned ostensibly by the bearer of holder thereof), in trust on behalf of the owners thereof. In addition, the Treasury has facilitated transfers of ownership of zero-coupon securities by accounting separately for the beneficial ownership of particular interest coupons and corpus payments on Treasury securities through the Federal Reserve book-entry record-keeping system. The Federal Reserve program as established by the Treasury Department is known as "STRIPS" or "Separate Trading of Registered Interest and Principal of Securities." Under the STRIPS program, the Fixed Income Fund will be able to have its beneficial ownership of U.S. Treasury zero-coupon securities recorded directly in the book-entry record-keeping system in lieu of having to hold certificates or other evidence of ownership of the underlying U.S. Treasury securities. When debt obligations have been stripped of their unmatured interest coupons by the holder, the stripped coupons are sold separately. The principal or corpus is sold at a deep discount because the buyer receives only the right to receive a future fixed payment on the security and does not receive any rights to periodic cash interest payments. Once stripped or separated, the corpus and coupons may be sold separately. Typically, the coupons are sold separately or grouped with other coupons with like maturity dates and sold in such bundled form. Purchasers of stripped obligations acquire, in effect, discount obligations that are economically identical to the zero-coupon securities issued directly by the obligor. FOREIGN INVESTMENTS The Fixed Income Fund may invest in foreign securities or securities denominated in or indexed to foreign currencies. In addition, the Fixed Income Fund may invest in foreign currencies. These may involve additional risks. Specifically, they may be affected by the strength of foreign currencies relative to the U.S. dollar, or by political or economic developments in foreign countries. Accounting procedures and government supervision may be less stringent than those applicable to U.S. companies. There may be less publicly available information about a foreign company than about a U.S. company. Foreign markets may be less liquid or more volatile than U.S. markets and may offer less protection to investors. It may also be more difficult to enforce contractual obligations abroad than would be the case in the United States because of differences in the legal systems. Foreign securities may be subject to foreign taxes, which may reduce yield, and may be less marketable than comparable U.S. securities. All these factors are considered by the Adviser before making any of these types of investments. RISK CHARACTERISTICS OF ASSET-BACKED SECURITIES The Fixed Income and U.S. Government Funds may invest in asset-backed securities. Asset-backed securities are created by the grouping of certain governmental, government-related and private loans, receivables and other lender assets into pools. Interests in these pools are sold as individual securities. Payments from the asset pools may be divided into several different tranches of debt securities, with some tranches entitled to receive regular installments of principal and interest, other tranches entitled to receive regular installments of interest, with principal payable at maturity or upon specified call dates, and other tranches only entitled to receive payments of principal and accrued interest at maturity or upon specified call dates. Different tranches of securities will bear different interest rates, which may be fixed or floating. Because the loans held in the asset pool often may be prepaid without penalty or premium, asset-backed securities and mortgage backed securities are generally subject to higher prepayment risks than most other types of debt instruments. Prepayment risks on mortgage securities tend to increase during periods of declining mortgage interest rates, because many borrowers refinance their mortgages to take advantage of the more favorable rates. Depending upon market conditions, the yield that the Fixed Income and U.S. Government Funds receive from the reinvestment of such prepayments, or any scheduled principal payments, may be lower than the yield on the original mortgage security. As a consequence, mortgage securities may be a less effective means of "locking in" interest rates than other types of debt securities having the same stated maturity and may also have less potential for capital appreciation. For certain types of asset pools, such as CMOs, prepayments may be allocated to one tranche of securities ahead of other tranches, in order to reduce the risk of prepayment for the other tranches. Prepayments may result in a capital loss to the Fixed Income and U.S. Government Funds to the extent that the prepaid mortgage securities were purchased at a market premium over their stated amount. Conversely, the prepayment of mortgage securities purchased at a market discount from their stated principal amount will accelerate the recognition of interest income by the Fixed Income and U.S. Government Funds which would be taxed as ordinary income when distributed to the shareholders. The credit characteristics of asset-backed securities also differ in a number of respects from those of traditional debt securities. The credit quality of most asset-backed securities depends primarily upon the credit quality of the assets underlying such securities, how well the entity issuing the securities is insulated from the credit risk of the originator or any other affiliated entities, and the amount and quality of any credit enhancement to such securities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies that have investment objectives and policies similar to its own. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) no Fund will own more than 3% of the total outstanding voting stock of any one investment company, (2) no Fund may invest more than 5% of its total assets in any one investment company and (3) no Fund may invest more than 10% of its total assets in investment companies in general. The Adviser will waive its investment advisory fee on assets invested in securities of other open-end investment companies. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one-third of the value of its total assets and pledge up to 15% (in the case of the Fixed Income Fund), or one-third (in the case of U.S. Government Fund) of the value of those assets to secure such borrowings. RESTRICTED AND ILLIQUID SECURITIES The Funds may invest up to 10% of their net assets in securities which are subject to restrictions on resale under federal securities law. In the case of the Fixed Income and U.S. Government Funds, this restriction is not applicable to commercial paper issued under Section 4(2) of the Securities Act of 1933. The Fixed Income Fund may invest up to 10% of its net assets in illiquid securities. The U.S. Government Fund may invest up to 15% of its net assets in illiquid securities. With respect to the Fixed Income and U.S. Government Funds, illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. DIVERSIFICATION With respect to 75% of the value of its total assets, no Fund may invest more than 5% of its total assets in securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government securities) or own more than 10% of the outstanding voting securities of one issuer. SELLING SHORT The Fixed Income Fund will not make short sales of securities, except in certain limited circumstances. The Fixed Income Fund has adopted the following limitations, which may be changed by the Trustees without shareholder approval. WARRANTS The Fixed Income Fund may not invest more than 5% of its net assets in warrants. No more than 2% of this 5% may be in warrants which are not listed on the New York or American Stock Exchanges. SHAREHOLDER GUIDE - ------------------------- ------------------------- - ------------------------- ------------------------- CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing Class A Shares, Class B Shares or Class C Shares. Your decision will be based on the amount of your intended purchase and how long you expect to hold the Shares. Each Fund offers three types of Investment Shares: Class A Shares, Class B Shares and Class C Shares. Each Share of a Fund represents an identical interest in the investment portfolio of the Fund and has the same rights. The difference between Class A Shares, Class B Shares, and Class C Shares is based on purchasing arrangements and distribution and shareholder services expenses. Class A Shares have a sales charge included at the time of purchase and are subject to a Rule 12b-1 distribution fee of 0.25%. This means that investors can purchase fewer Class A Shares for the same initial investment than Class B Shares or Class C Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class B Shares impose a maximum contingent deferred sales charge ("CDSC") of 5.00%. In addition, Class B Shares impose a CDSC on most redemptions made within seven years of purchase, and have higher distribution costs resulting from a Rule 12b-1 fee of 0.75% and a shareholder services fee of 0.25%. In addition, at the end of the seven year period, Class B Shares may automatically convert to Class A Shares and thus be subject to lower Rule 12b-1 distribution fees. Class C Shares impose a CDSC of 1.00% on most redemptions made within the first 12 months of purchase, have a Rule 12b-1 distribution fee of 0.75%, and a shareholder services fee of 0.25%. This means that investors may purchase more Class B Shares or Class C Shares than Class A Shares for the same initial investment, but will receive lower dividends per Share. Investors should consider whether, during the anticipated life of their investment in the Funds, the accumulated Rule 12b-1 fees, CDSC, and shareholder services fee on either Class B Shares or Class C Shares would be less than the initial sales charge and accumulated Rule 12b-1 fees on Class A Shares purchased at the same time. Investors must also consider how each differential would be offset by the higher yield of Class A Shares. SHARE PRICE CALCULATION The net asset value of a Fund Share equals the market value of all the Fund's portfolio securities divided by the total Shares outstanding. It is also the bid price. The offering price is quoted after adding a sales charge to the net asset value. Purchases, redemptions, and exchanges are all based on net asset value. (The purchase price of Class A Shares adds an applicable sales charge, and the redemption proceeds of Class B Shares and Class C Shares deduct an applicable CDSC.) The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Class A Shares, Class B Shares and Class C Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yields of Class A Shares, Class B Shares and Class C Shares are calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Class A Shares, Class B Shares and Class C Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Performance information for the Class A Shares, Class B Shares and Class C Shares reflects the effect of a sales charge which, if excluded, would increase the total return and yield. Total return and yield will be calculated separately for Class A Shares, Class B Shares, Class C Shares and Y Shares of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee, and Class B Shares and Class C Shares are subject to a Rule 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY - ------------------------- ------------------------- - ------------------------- ------------------------- SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order, plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (in the case of Class A Shares), or (ii) on a contingent deferred basis (in the case of Class B Shares or Class C Shares). MINIMUM INVESTMENT You may invest as often as you want in the Funds. There is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Mutual Funds Group of First Union Brokerage Services ("FUBS"), a subsidiary of First Union, at 1-800-326-3241. Subsequent investments may be in any amounts. WHAT SHARES COST Class A Shares are sold at their net asset value plus a sales charge as follows: Sales Charge as Sales Charge as a a Percentage of Percentage of Net Amount of Transaction Public Offering Price Amount Invested - --------------------- --------------------- ----------------- $ 0-$ 99,999 4.75% 4.99% $ 100,000-$ 249,999 3.75% 3.90% $ 250,000-$ 499,999 3.00% 3.10% $ 500,000-$ 999,999 2.00% 2.04% $1,000,000-$2,499,999 1.00% 1.01% $2,500,000+ 0.25% 0.25% Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. (the "distributor" or "FSC") and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non-qualified employee benefit and savings plans which make Shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount up to .50 of 1% of the net asset value of the Class A Shares purchased. These payments are subject to reclaim in the event the Class A Shares are redeemed within 12 months after purchase. Sales charges may be reduced in some cases. You may be entitled to a reduction if: (1) you make a single large purchase, (2) you, your spouse and/or children (under 21 years) make Fund purchases on the same day, (3) you make an additional purchase to add to an existing account, (4) you sign a letter of intent indicating your intention to purchase at least $100,000 of Shares over the next 13 months, (5) you reinvest in a Fund within 30 days of redemption, or (6) you combine purchases of two or more First Union Funds which include front- end sales charges. In all of these cases, you must notify the distributor of your intentions, in writing, in order to qualify for a sales charge reduction. For more information, consult the Funds' Statements of Additional Information or the distributor. Class B Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within seven years of their purchase will be subject to a CDSC according to the following schedule (applicable only to purchases beginning September 1, 1994): Year of Redemption Contingent Deferred After Purchase Sales Charge - ------------------ ------------------- First 5.0% Second 4.0% Third 3.0% Fourth 3.0% Fifth 2.0% Sixth 1.0% Seventh 1.0% Class C Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within one year of their purchase will be subject to a CDSC of 1.00%. With respect to Class B Shares and Class C Shares, no CDSC will be imposed on: (1) the portion of redemption proceeds attributable to increases in the value of the account due to increases in the net asset value per Share, (2) Shares acquired through reinvestment of dividends and capital gains, (3) Shares held for more than seven years (in the case of Class B Shares) or one year (in the case of Class C Shares) after the end of the calendar month of acquisition, (4) accounts following the death or disability of a shareholder, or (5) minimum required distributions to a shareholder over the age of 70 1/2 from an IRA or other retirement plan. CONVERSION FEATURE Class B Shares include all Shares purchased pursuant to the deferred sales charge alternative which have been outstanding for less than the period ending seven years after the end of the month in which the shareholder's order to purchase Class B Shares was accepted. At the end of this seven year period, Class B Shares may automatically convert to Class A Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class B Shares. Such conversion will be on the basis of the relative net asset values of the two classes, without the imposition of any sales load, fee or other charge. The purpose of the conversion feature is to relieve the holders of the Class B Shares that have been outstanding for a period of time sufficient for the distributor to have been compensated for distribution expenses related to the Class B Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class A Shares, Class B Shares purchased through the reinvestment of dividends and distributions paid on Class B Shares in a shareholder's Fund account will be considered to be held in a separate sub- account. Each time any Class B Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class A Shares, an equal pro rata portion of the Class B Shares in the sub-account will also convert to Class A Shares. The availability of the conversion feature is subject to the granting of an exemptive order (the "Order") by the Securities and Exchange Commission (the "SEC") or the adoption of a rule permitting such conversion. In the event that the Order or rule ultimately issued by the SEC requires any conditions additional to those described in this prospectus, shareholders will be notified. BY TELEPHONE OR IN PERSON You may purchase Class A Shares, Class B Shares and Class C Shares by telephone from the Mutual Funds Group of FUBS at 1-800-326-3241 or you may place the order in person at any First Union branch location. Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. All purchase orders received prior to 4:00 p.m. (Eastern time) on a regular business day are processed at that day's offering price. Payment is required within five business days. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. DEALER CONCESSION For sales of Shares of the Funds, a dealer will normally receive up to 85% of the applicable sales charge. Any portion of the sales charge which is not paid to a dealer will be retained by the distributor. However, the distributor, in its sole discretion, may uniformly offer to pay to all dealers selling Shares of the Funds, all or a portion of the sales charge it normally retains. If accepted by the dealer, such additional payments will be predicated upon the amount of Fund Shares sold. The sales charge for Shares sold other than through registered broker/dealers will be retained by FSC. FSC may pay fees to banks out of the sales charge in exchange for sales and/or administrative services performed on behalf of the bank's customers in connection with the initiation of customer accounts and purchases of Shares. From time to time, the distributor will conduct sales programs or contests that compensate brokers with cash or non-cash items, such as merchandise and attendance at sales seminars in resort locations. The cost of such compensation is borne by the distributor and is not a Fund expense. HOW TO CONVERT YOUR INVESTMENT - ------------------------- FROM ONE ------------------------- - ------------------------- ------------------------- FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call FUBS at 1-800-326-3241 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Class A Shares of one First Union Fund for Class A Shares of any other First Union Fund, Class B Shares of one First Union Fund for Class B Shares of any other First Union Fund, or Class C Shares of one First Union Fund for shares of any other First Union Fund by calling toll free 1-800-326-3241 or by writing to FUBS. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. The exchange of Class B Shares or Class C Shares will not be subject to a CDSC. However, if the shareholder redeems Class B Shares within seven years of the original purchase or Class C Shares within one year of the original purchase, a CDSC will be imposed. For purposes of computing the CDSC, the length of time the shareholder has owned Class B Shares or Class C Shares will be measured from the date of original purchase and will not be affected by the exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO - ------------------------- ------------------------- - ------------------------- ------------------------- REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less, in the case of Class B Shares or Class C Shares, any applicable CDSC. You may redeem Shares in three ways: (1) by telephoning FUBS at 1-800-326-3241, (2) by written request to FUBS or Federated Services Company, c/o State Street Bank and Trust Company, P.O. Box 8609, Boston, Massachusetts 02266-8609, or (3) in person at First Union. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record, normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. ADDITIONAL SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- SERVICES TELEPHONE SERVICES You may authorize electronic transfers of money to purchase Shares in any amount or to redeem any or all Shares in an account. The service may be used like an "electronic check" to move money between a bank account and an account in a Fund with a single telephone call. SYSTEMATIC INVESTMENT PLAN You may arrange for systematic monthly or quarterly investments in your account in amounts of $25 or more by directly debiting your bank account. TAX SHELTERED PLANS You may open a pension and profit sharing account in any First Union Fund (except those First Union Funds having an objective of providing tax free income), including Individual Retirement Accounts ("IRAs"), Rollover IRAs, Keogh Plans, Corporate Profit-Sharing, Pension and Salary-Reduction Plans. For details, including fees and application forms, call First Union toll free at 1- 800-669-2136 or write to First Union National Bank of North Carolina, Retirement Services, 301 South College Street, Charlotte, NC 28288-1169. SYSTEMATIC CASH WITHDRAWAL PLAN When an account of $10,000 or more is opened or when an existing account reaches that size, you may participate in a Fund's Systematic Cash Withdrawal Plan by filling out the appropriate part of the share purchase application. Under this plan, you may receive (or designate a third party to receive) a monthly or quarterly check in a stated amount of not less than $25. Fund Shares will be redeemed as necessary to meet withdrawal payments. All participants must elect to have their dividends and capital gain distributions reinvested automatically. Any applicable Class B Shares CDSC will be waived with respect to redemptions occurring under a Systematic Cash Withdrawal Plan during a calendar year to the extent that such redemptions do not exceed 10% of (i) the initial value of the account, plus (ii) the value, at the time of purchase, of any subsequent investments. MANAGEMENT OF - ------------------------- ------------------------- - ------------------------- ------------------------- FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. Thomas L. Ellis is a Vice President of First Union National Bank of North Carolina, N.A. Prior to joining First Union in 1985, Mr. Ellis had seventeen years of investment management and sales experience including eleven years marketing short and medium-term obligations to institutional investors, plus three years as head trader for First Boston Corporation. Mr. Ellis has managed the Fixed Income Fund since its inception in July 1988. Rollin C. Williams is a Vice President of First Union National Bank of North Carolina, N.A. and has over 24 years of investment management experience. Mr. Williams was the Head of Fixed Income Investments at Dominion Trust Company from 1988 until its acquisition by First Union Corporation. Mr. Williams has served as the portfolio manager for the U.S. Government Fund since its inception in December 1992. DISTRIBUTION OF INVESTMENT SHARES FSC, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Each class of Investment Shares of a Fund has adopted a separate plan for distribution of Shares permitted by Rule 12b-1 under the Investment Company Act of 1940 (the "Plans"), whereby each Fund has authorized a daily expense ("Rule 12b-1 fee") at an annual rate of up to 0.75 of 1% of the average daily net asset value of that Fund's respective class to finance the sale of Shares. It is currently intended that annual Rule 12b-1 fees will be limited for the foreseeable future to payments to the distributor equal to 0.10 of 1% for Class A Shares of the Fixed Income Fund, 0.25 of 1% for Class A Shares of the U.S. Government Fund, and 0.75 of 1% for Class B Shares and Class C Shares of each respective Fund's average daily net asset value. The distributor may pay all or a portion of the Rule 12b-1 fee to compensate selected brokers and financial institutions for selling Shares or for administrative services rendered in connection with the Shares. The Funds make no payments in connection with the sale of Shares other than the Rule 12b-1 fees paid to the distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. Except as set forth in the next paragraph, the Funds do not pay for unreimbursed expenses of the distributor. Since the Funds' Plans are "compensation" type plans, however, future Rule 12b-1 fees may permit recovery of such amounts or may result in a profit to the distributor. The distributor may sell, assign or pledge its right to receive Rule 12b-1 fees and CDSCs to finance payments made to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class B Shares and Class C Shares at any given time may exceed the Rule 12b-1 fees and payments received pursuant to CDSCs. These unrecovered amounts, plus interest thereon, will be carried forward and paid from future Rule 12b-1 fees and payments received through CDSCs. If a Plan were terminated or not continued, the Funds would not be contractually obligated to pay for any expenses not previously reimbursed by the Funds or recovered through CDSCs. FSC, from time to time, may pay brokers additional sums of cash or promotional incentives based upon the amount of Shares sold. Such payments, if made, will be in addition to amounts paid under the Plans and will not be an expense of the Funds. FUND ADMINISTRATION Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. The Funds may pay a shareholder servicing agent (the "Shareholder Servicing Agent") a fee based on average daily net asset value for Class B Shares and Class C Shares of the Funds for which the Shareholder Servicing Agent provides shareholder services. As such, the Shareholder Servicing Agent provides shareholder services which include, but are not limited to, distributing prospectuses and other information, providing shareholder assistance, and communicating or facilitating purchases and redemptions of Class B Shares and Class C Shares. The Funds may pay the Shareholder Servicing Agent a fee equal to 0.25 of 1% of the average daily net asset value of Class B Shares and Class C Shares for which the Shareholder Servicing Agent provides shareholder services. The Shareholder Servicing Agent may voluntarily choose to waive all or a portion of its fee at any time. First Union Brokerage Services, First Union, and other financial institutions may serve as Shareholder Servicing Agent. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES - ------------------------- ------------------------- - ------------------------- ------------------------- Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.50 of 1% of each of the Income Funds' average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust - ------------------- ----------------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND INVESTMENT SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering the Fund and Shares of the Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND - ------------------------- ------------------------- - ------------------------- ------------------------- PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 32,878,796 shares (92.54%), 8,511,525 shares (91.53%), and 1,373,452 shares (81.21%), respectively, of Fixed Income Fund--Y Shares, Managed Bond Fund--Y Shares, and U.S. Government Fund--Y Shares; and FUBS, for the exclusive benefit of Merle Adair Connell Trust, Winter Garden, Florida, and for the exclusive benefit of Helen G. Bender, Wildwood, Florida, and acting in various capacities for numerous accounts was the owner of record of 10,834 shares (36.90%) and 11,037 shares (37.59%), respectively, of the U.S. Government Fund--Class C Investment Shares, and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS - ------------------------ ------------------------ - ------------------------ ------------------------ AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid monthly for the Fixed Income Fund, and dividends are declared daily and paid monthly for the U.S. Government Fund. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or FUBS in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX INFORMATION - ------------------------ ------------------------ - ------------------------ ------------------------ Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. All shareholders, unless otherwise exempt, are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES - ------------------------- ------------------------- - ------------------------- ------------------------- OF SHARES First Union Income Funds, except for First Union Managed Bond Portfolio, offer four classes of shares: Class A Shares, Class B Shares, and Class C Shares for individuals and other customers of First Union, and Y Shares for institutional investors. Y Shares of First Union Income Funds are sold to accounts for which First Union or other financial institutions act in a fiduciary or agency capacity at net asset value without a sales charge at a minimum investment of $1,000. Y Shares are not sold pursuant to a Rule 12b-1 plan. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares, and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either call FUBS, at 1-800-326- 3241, or write the Trust. ADDRESSES - ------------------------- ------------------------- - ------------------------- ------------------------- - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- FEDERATED SECURITIES CORP., DISTRIBUTOR 535675 (20/PKG.) G00850-07 (2/95) FIRST UNION FIXED INCOME PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union Fixed Income Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares', Class B Investment Shares' or Class C Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 Asset-Backed Securities Collateralized Mortgage Obligations (CMOs) 1 Restricted and Illiquid Securities 2 When-Issued and Delayed Delivery Transactions 2 Options and Futures Transactions 2 Lending of Portfolio Securities 3 Reverse Repurchase Agreements 3 Foreign Currency Transactions 3 Portfolio Turnover 4 Investment Limitations 4 FIRST UNION FUNDS MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 8 Trustees Compensation 8 Trustee Liability 8 INVESTMENT ADVISORY SERVICES 9 - --------------------------------------------------------------- Adviser to the Fund 9 Advisory Fees 9 BROKERAGE TRANSACTIONS 9 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - --------------------------------------------------------------- PURCHASING SHARES 10 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 11 Shareholder Services Plan 11 DETERMINING NET ASSET VALUE 11 - --------------------------------------------------------------- Determining Market Value of Securities 11 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 12 - --------------------------------------------------------------- The Fund's Tax Status 12 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 13 - --------------------------------------------------------------- FINANCIAL STATEMENTS 14 - --------------------------------------------------------------- APPENDIX 15 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Fixed Income Portfolio (the "Fund") is a portfolio in First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVES AND POLICIES - -------------------------------------------------------------------------------- The primary investment objective of the Fund is to provide a high level of current income. Capital growth is a secondary objective. The investment objectives cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund invests primarily in investment grade debt securities which include: .domestic issues of corporate debt obligations (rated A or higher by Moody's Investors Service, Inc. or Standard & Poor's Ratings Group); and .obligations issued or guaranteed by the U.S. government, its agencies, or instrumentalities. U.S. GOVERNMENT OBLIGATIONS . The types of U.S. government obligations in which the Fund may invest generally include obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: . the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or . the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: . Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks, and Banks for Cooperatives; . Farmers Home Administration; . Federal Home Loan Banks; . Federal Home Loan Mortgage Corporation; . Federal National Mortgage Association; . Government National Mortgage Association; and . Student Loan Marketing Association. ASSET-BACKED SECURITIES Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of asset-backed securities backed by automobile receivables permit the servicers of such receivables to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related asset-backed securities. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of asset-backed securities backed by automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. In general, issues of asset-backed securities are structured to include additional collateral and/or additional credit support to protect against the risk that a portion of the collateral supporting the asset-backed securities may default and/or may suffer from these defects. In evaluating the strength of particular issues of asset-backed securities, the Fund's adviser considers the financial strength of the guarantor or other provider of credit support, the type and extent of credit enhancement provided as well as the documentation and structure of the issue itself and the credit support. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) Privately issued CMOs generally represent an ownership interest in federal agency mortgage pass-through securities such as those issued by Government National Mortgage Association. The terms and characteristics of the mortgage instruments may vary among pass-through mortgage loan pools. Most of the CMOs in which the Fund would invest use the same basic structure: .Several classes of securities are issued against a pool of mortgage collateral. The most common structure contains four classes of securities: the first three (A, B, and C bonds) pay interest at their stated rates beginning with the issue date; the final class (or Z bond) typically receives the residual income from the underlying investment after payments are made to the other classes. .The cash flows from the underlying mortgages are applied first to pay interest and then to retire securities. .The classes of securities are retired sequentially. All principal payments are directed first to the shortest maturity class (or A bonds). When those securities are completely retired, all principal payments are then directed to the next-shortest-maturity security (or B bond). This process continues until all of the classes have been paid off. The market for such CMOs has expanded considerably since its inception. The size of the primary issuance market and the active participation in the secondary market by securities dealers and other investors make government-related pools highly liquid. RESTRICTED AND ILLIQUID SECURITIES The ability of the Board of Trustees ("Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under the Rule) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS Options which the Fund will trade must be listed on national securities exchanges. Exchanges on which such options currently are traded are the Chicago Board Options Exchange and the New York, American, Pacific and Philadelphia Stock Exchanges ("Exchanges"). PURCHASING PUT AND CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at an undetermined price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put and call options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the put option will increase in value. In such an event, the Fund will normally close out its option by selling an identical put option. If the hedge is successful, the proceeds received by the Fund upon the sale of the put option will be large enough to offset both the premium paid by the Fund for the put option plus the realized decrease in value of the hedged securities. Alternately, the Fund may exercise its put option to close out the position. To do so, it would enter into a futures contract of the type underlying the option. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and only the premium paid for the contract will be lost. PURCHASING OPTIONS The Fund may purchase call and put options for the purpose of offsetting previously written call and put options of the same series. If the Fund is unable to effect a closing purchase transaction with respect to covered option it has written, the Fund will not be able to sell the underlying securities or dispose of assets held in a segregated account until the options expire or are exercised. The Fund currently does not intend to invest more than 5% of its net assets in options transactions. The Fund intends to purchase put and call options on currency and other financial futures contracts for hedging purposes. A put option purchased by the Fund would give it the right to assume a position as the seller of a futures contract. A call option purchased by the Fund would give it the right to assume a position as the purchaser of a futures contract. The purchase of an option on a futures contract requires the Fund to pay a premium. In exchange for the premium, the Fund becomes entitled to exercise the benefits, if any, provided by the futures contract, but is not required to take any action under the contract. If the option cannot be exercised profitably before it expires, the Fund's loss will be limited to the amount of the premium and any transaction costs. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and, thereby, insure that the use of such futures contracts is unleveraged. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. FOREIGN CURRENCY TRANSACTIONS As one way of managing exchange rate risk, the Fund may enter into forward currency exchange contracts (agreements to purchase or sell currencies at a specified price and date). The exchange rate for the transaction (the amount of currency a Fund will deliver and receive when the contract is completed) is fixed when the Fund enters into the contract. The Fund usually will enter into these contracts to stabilize the U.S. dollar value of a security it has agreed to buy or sell. The Fund intends to use these contracts to hedge the U.S. dollar value of a security it already owns, particularly if the Fund expects a decrease in the value of the currency in which the foreign security is denominated. Although the Fund will attempt to benefit from using forward contracts, the success of its hedging strategy will depend on the Adviser's ability to predict accurately the future exchange rates between foreign currencies and the U.S. dollar. The value of the Fund's investments denominated in foreign currencies will depend on the relative strengths of those currencies and the U.S. dollar, and the Fund may be affected favorably or unfavorably by changes in the exchange rates or exchange control regulations between foreign currencies and the dollar. Changes in foreign currency exchange rates also may affect the value of dividends and interest earned, gains and losses realized on the sale of securities and net investment income and gains, if any, to be distributed to shareholders by the Fund. The Fund may also purchase and sell options related to foreign currencies in connection with hedging strategies. The Fund will not enter into forward contracts for hedging purposes in a particular currency in an amount in excess of the Fund's assets denominated in that currency, but as consistent with its other investment policies, is not otherwise limited in its ability to use this strategy. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. The portfolio turnover rates for the fiscal years ended December 31, 1994 and 1993 were 48% and 73%, respectively. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. The use of short sales will allow the Fund to retain certain bonds in its portfolio longer than it would without such sales. To the extent that the Fund receives the current income produced by such bonds for a longer period than it might otherwise, the Fund's investment objective of current income is furthered. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes and then only in amounts not in excess of 5% of the value of its total assets or in an amount up to one-third of the value of its total assets, including the amount borrowed, in order to meet redemption requests without immediately selling portfolio instruments. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of the value of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, although it may invest in the securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. However, the Fund may enter into futures contracts on financial instruments or currency and sell or buy options on such contracts. RESTRICTED SECURITIES The Fund will not invest more than 10% of the value of its net assets in securities subject to restrictions on resale under federal securities laws. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objectives, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities in accordance with its investment objectives, policies and limitations or lend portfolio securities valued at more than 15% of its total assets to broker/dealers. CONCENTRATION OF INVESTMENTS The Fund will not invest 25% or more of the value of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by U.S. government, its agencies or instrumentalities. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase securities of any one issuer (other than cash, cash items or securities issued or guaranteed by the U.S. government, its agencies or instrumentalities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of the value of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities not determined by the Trustees to be liquid. The above investment limitations cannot be changed without shareholder approval. The following investment limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of its total assets in securities of unseasoned issuers, including their predecessors, that have been in operation for less than three years. INVESTING IN WARRANTS The Fund will not invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities. To comply with certain state restrictions, the Fund will limit its investment in such warrants not listed on the New York or American Stock Exchange to 2% of its net assets. (If state restrictions change, this latter restriction may be revised without notice to shareholders.) For purposes of this investment restriction, warrants acquired by the Fund in units or attached to securities may be deemed to be without value. Although not fundamental restrictions or policies requiring a shareholder vote, the Fund has also undertaken the following limitation to a state securities authority for as long as the state authority requires and shares of the Fund are registered for sale in that state. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. In order to comply with registration requirements of a certain state, the Fund will not invest in real estate limited partnerships. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary Physician Care 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Y shares of the Fund: First Union National Bank, Charlotte, North Carolina, owned approximately 2,649,423 Shares (7.46%) and First Union National Bank Trust Accounts, Charlotte, North Carolina, owned approximately 32,878,796 Shares (92.54%). As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Sidney Goldberg, Deerfield, Florida, owned approximately 7,099 Shares (13.15%); FUBS, for the exclusive benefit of Wayne C. Shultz IRA, Griffin, Georgia, owned approximately 3,119 Shares (5.78%); FUBS, for the exclusive benefit of Robert S. New Sr. and Willa May New, Pensacola, Florida, owned approximately 3,121 Shares (5.78%); FUBS, for the exclusive benefit of Kerry D. Fitzgerald GDN, Christina Griffin, Ft. Lauderdale, Florida, owned approximately 10,305 Shares (19.09%); FUBS, for the exclusive benefit of Francis O. Hunt and Mitchell W. Hunt, Lexington, North Carolina, owned approximately 3,147 Shares (5.83%); FUBS, for the exclusive benefit of Lucile L. Murray, Atlanta, Georgia, owned approximately 10,277 Shares (19.03%); FUBS, for the exclusive benefit of Melissa Gerace, Atlanta, Georgia, owned approximately 3,121 Shares (5.78%); and FUBS, for the exclusive benefit of Kathleen W. Gladfelter, Atlanta, Georgia, owned approximately 3,653 Shares (6.77%). TRUSTEES COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationship with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned advisory fees of $2,022,773, $1,894,693, and $1,531,707, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $9,198, $7,908, and $15,573, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $341,243, $331,342, and $282,292, respectively, in administrative service costs. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: . quantity discounts and accumulated purchases; . signing a 13-month letter of intent; . using the reinvestment privilege; or . concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A, CLASS B AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B and Class C Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A, Class B and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $21,670 in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $108,896 in distribution services fees on behalf of Class B Investment Shares. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $918 in distribution services fees on behalf of Class C Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $14,697 and $306, respectively, on behalf of Class B Investment Shares and Class C Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market values of the Fund's portfolio securities, other than options, are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the current closing bid and asked prices and for bonds and other fixed income securities as determined by an independent pricing service; .for short-term obligations, according to the mean between bid and asked prices, as furnished by an independent pricing service,, or for short-term obligations with remaining maturities of less than 60 days at the time of purchase, at amortized cost unless the Trustees determine this is not fair value; or .at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. The Fund will value futures contracts, options, put and call options on futures and financial futures at their market values established by the Exchanges at the close of option trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing option positions is necessary. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Y Shares for the one-year period ended December 31, 1994, and for the period from December 31, 1990 (start of performance) to December 31, 1994 were (2.55%) and 6.48%, respectively. The Fund's average annual total returns for Class A Investment Shares for the one-year period ended December 31, 1994, and for the period from January 31, 1989 (start of performance) to December 31, 1994 were (7.20%) and 6.50%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1994, and for the period from January 25, 1993 (start of performance) to December 31, 1994 were (8.20%) and (0.80%), respectively. The Fund's cumulative total return for Class C Investment Shares for the period from September 2, 1994 (start of performance) to December 31, 1994 was (2.30%). The average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of shares owned at the end of the period by the net asset value per share at the end of the period. The number of shares owned at the end of the period is based on the number of shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional shares, assuming a quarterly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of Shares redeemed. Cumulative total return reflects the Class C Investment Shares' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. The Class C Investment Shares' total return is representative of only four months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 6.97%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 6.53%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 5.95%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1994 was 5.95%. The yield for all classes of shares of the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by any class of Shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LEHMAN BROTHERS GOVERNMENT/CORPORATE BOND INDEX is comprised of approximately 5,000 issues, which include: non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasi-federal corporations; and publicly issued, fixed rate, non-convertible domestic bonds of companies in industry, public utilities, and finance. The average maturity of these bonds approximates nine years. Tracked by Lehman Brothers, Inc., the index calculates total returns for one-month, three-month, twelve-month, and ten-year periods and year-to-date. .SALOMON BROTHERS AAA-AA CORPORATE index calculates total returns of approximately 775 issues which include long-term, high grade domestic corporate taxable bonds, rated AAA-AA with maturities of twelve years or more and companies in industry, public utilities, and finance. .LEHMAN BROTHERS INTERMEDIATE GOVERNMENT/CORPORATE BOND INDEX is comprised of issues which include: non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasi-federal corporations; and publicly issued, fixed rate, non-convertible domestic bonds of companies in industry, public utilities, and finance. The average maturity of these bonds is between 1 and 9.9 years. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Fixed Income Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located in the inside back cover of the respective prospectus. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. MOODY'S INVESTORS SERVICE, INC. CORPORATE BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. BAA--Bonds which are rated BAA are considered as medium-grade obligations, (i.e., they are neither highly protected nor poorly secured.) Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATING DEFINITIONS A-1--This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation. MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATING DEFINITIONS PRIME-1--Issuers rated PRIME-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. PRIME-1 repayment capacity will normally be evidenced by the following characteristics: .Leading market positions in well established industries. .High rates of return on funds employed. .Conservative capitalization structure with moderate reliance on debt and ample asset protection. .Broad margins in earning coverage of fixed financial charges and high internal cash generation. .Well-established access to a range of financial markets and assured sources of alternate liquidity. G00850-22 (2/95) FIRST UNION MANAGED BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information should be read with the prospectus of Y Shares for First Union Managed Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 Restricted and Illiquid Securities 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 2 Lending of Portfolio Securities 3 Reverse Repurchase Agreements 3 Portfolio Turnover 3 Investment Limitations 3 FIRST UNION FUNDS MANAGEMENT 5 - --------------------------------------------------------------- Officers and Trustees 5 Fund Ownership 7 Trustees Compensation 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- DETERMINING NET ASSET VALUE 9 - --------------------------------------------------------------- Determining Market Value of Securities 9 REDEEMING SHARES 9 - --------------------------------------------------------------- Redemption in Kind 9 TAX STATUS 10 - --------------------------------------------------------------- The Fund's Tax Status 10 Shareholders' Tax Status 10 TOTAL RETURN 10 - --------------------------------------------------------------- YIELD 10 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 10 - --------------------------------------------------------------- FINANCIAL STATEMENTS 11 - --------------------------------------------------------------- APPENDIX 12 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Managed Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." The Trust has established one class of shares: Y Shares ("Shares"). This Statement of Additional Information relates to the Y Shares of the Fund. INVESTMENT OBJECTIVES AND POLICIES - -------------------------------------------------------------------------------- The investment objective of the Fund is to achieve total return. The investment objective cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund invests primarily in high grade bonds, which include domestic issues of corporate debt obligations rated A or better by Moody's Investors Service, Inc. or Standard & Poor's Ratings Group, and obligations issued or guaranteed by the U.S. government, its agencies, or instrumentalities. U.S. GOVERNMENT OBLIGATIONS The types of U.S. government obligations in which the Fund may invest generally include obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: . the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or . the credit of the agency or instrumentality issuing the obligations. . Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: . Farm Credit System, including the National Bank of Cooperatives, Farm Credit Banks, and Banks for Cooperatives; . Farmers Home Administration; . Federal Home Loan Banks . Federal Home Loan Mortgage Corporation; . Federal National Mortgage Association; . Government National Mortgage Association; and . Student Loan Marketing Association. RESTRICTED AND ILLIQUID SECURITIES The ability of the Board of Trustees ("Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under the Rule) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: . the frequency of trades and quotes for the security; . the number of dealers willing to purchase or sell the security and the number of other potential buyers; . dealer undertakings to make a market in the security; and . the nature of the security and the nature of the marketplace trades. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS As a means of reducing fluctuations in the net asset value of Shares of the Fund, the Fund may attempt to hedge all or a portion of its portfolio through the purchase of put and call options on portfolio securities and listed put options on financial futures contracts for portfolio securities. The Fund may also write covered call options on its portfolio securities and covered put options to attempt to increase its current income. The aggregate value of the obligations underlying the puts will not exceed 5% of the Fund's net assets. This policy cannot be changed without shareholder approval. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a predetermined price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the put option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the put option will be large enough to offset both the premium paid by the Fund for the put option plus the realized decrease in value of the hedged securities. Alternately, the Fund may exercise its put option to close out the position. To do so, it would enter into a futures contract of the type underlying the option. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and only the premium paid for the contract will be lost. LIMITATION ON OPEN FUTURES POSITION The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures position. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and thereby insure that the use of such futures contracts is unleveraged. PURCHASING OPTIONS The Fund may purchase both put and call options on its portfolio securities. These options will be used as a hedge to attempt to protect securities which the Fund holds or will be purchasing against decreases or increases in value. The Fund may purchase call and put options for the purpose of offsetting previously written call options of the same series. If the Fund is unable to effect a closing purchase transaction with respect to covered options it has written, the Fund will not be able to sell the underlying securities or dispose of assets held in a segregated account until the options expire or are exercised. The Fund currently does not intend to invest more than 5% of its net assets in options transactions. The Fund intends to purchase put and call options on currency and other financial futures contracts for hedging purposes. A put option purchased by the Fund would give it the right to assume a position as the seller of a futures contract. A call option purchased by the Fund would give it the right to assume a position as the purchaser of a futures contract. The purchase of an option on a futures contract requires the Fund to pay a premium. In exchange for the premium, the Fund becomes entitled to exercise the benefits, if any, provided by the futures contract, but is not required to take any action under the contract. If the option cannot be exercised profitably before it expires, the Fund's loss will be limited to the amount of the premium and any transaction costs. OPTIONS TRADING MARKETS Options which the Fund will trade must be listed on national securities exchanges. Exchanges on which such options currently are traded are the Chicago Board Options Exchange and the New York, American, Pacific and Philadelphia Stock Exchanges ("Exchanges"). LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. The portfolio turnover rates for the fiscal years ended December 31, 1994 and 1993 were 32% and 53%, respectively. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. The use of short sales will allow the Fund to retain certain bonds in its portfolio longer than it would without such sales. To the extent that the Fund receives the current income produced by such bonds for a longer period than it might otherwise, the Fund's investment objective of current income is furthered. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money and engage in reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amounts borrowed. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure or to facilitate management of the portfolio by enabling the Fund to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Fund will not purchase any securities while any borrowings are outstanding. During the period any reverse repurchase agreements are outstanding, but only to the extent necessary to assure completion of the reverse repurchase agreements, the Fund will restrict the purchase of portfolio instruments to money market instruments maturing on or before the expiration date of the reverse repurchase agreements. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. Margin deposits for the purchase and sale of financial futures contracts and related options are not deemed to be a pledge. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, although it may invest in the securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. However, the Fund may enter into futures contracts on financial instruments or currency and sell or buy options on such contracts. RESTRICTED SECURITIES The Fund will not invest more than 10% of its net assets in securities subject to restrictions on resale under the Securities Act of 1933 (except for certain restricted securities which meet the criteria for liquidity established by the Trustees). UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities in accordance with its investment objective, policies and limitations. CONCENTRATION OF INVESTMENTS The Fund will not invest 25% or more of the value of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by U.S. government, its agencies or instrumentalities. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase securities of any one issuer (other than cash, cash items or securities issued or guaranteed by the U.S. government, its agencies or instrumentalities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. The above investment limitations cannot be changed without shareholder approval. The following investment limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of its net assets in securities which are illiquid, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities determined by the Trustees not to be liquid. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. In addition, the Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary Physician Care 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank, Charlotte, North Carolina, owned approximately 538,538 Shares (5.79%) and First Union National Bank, Charlotte, North Carolina, owned approximately 8,511,525 Shares (91.53%). TRUSTEES COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Petit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned advisory fees of $523,270, $576,619, and $591,232, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $10,088, $1,662, and $16,922, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $88,279, $101,082, and $109,032, respectively, in administrative service costs, of which $10,687, $36,701, and $52,759, respectively, were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the prospectus under "How to Buy Shares." ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plan for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which net asset value of Shares is calculated by the Fund are described in the prospectus. DETERMINING MARKET VALUE OF SECURITIES The market value of the Fund's portfolio securities, other than options, are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the current closing bid and asked prices and for bonds and other fixed income securities as determined by an independent pricing service; .for short-term obligations, according to the mean between bid and asked prices, as furnished by an independent pricing service, or for short-term obligations with remaining maturities of less than 60 days at the time of purchase, at amortized cost unless the Trustees determine this is not fair value; or .at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. The Fund will value futures contracts, options, put and call options on futures and financial futures at their market values established by the Exchanges at the close of option trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing option positions is necessary. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request. Redemptions will be made on days on which the Fund computes its net asset value. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Y Shares for the one year period ended December 31, 1994 and for the period from April 1, 1991 (start of performance) to December 31, 1994, were (4.40%) and 6.06%, respectively. The average annual total return for Y Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of shares owned at the end of the period by the net asset value per share at the end of the period. The number of shares owned at the end of the period is based on the number of shares purchased at the beginning of the period with $1,000, adjusted over the period by any additional shares, assuming the monthly reinvestment of all dividends and distributions. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 7.35%. The yield for Y Shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC) earned over a thirty-day period by the maximum offering price per share on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned because of certain adjustments required by the SEC and therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's expenses; and .various other factors. The performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LEHMAN BROTHERS GOVERNMENT/CORPORATE BOND INDEX is comprised of approximately 5,000 issues, which include: non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasi-federal corporations; and publicly issued, fixed rate, non-convertible domestic bonds of companies in industry, public utilities, and finance. The average maturity of these bonds approximates nine years. Tracked by Lehman Brothers, Inc., the index calculates total returns for one-month, three-month, twelve-month, and ten-year periods and year-to-date. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .SALOMON BROTHERS AAA-AA CORPORATE index calculates total returns of approximately 775 issues which include long-term, high grade domestic corporate taxable bonds, rated AAA-AA with maturities of twelve years or more and companies in industry, public utilities, and finance. .SALOMON BROTHERS BROAD INVESTMENT-GRADE (BIG) BOND INDEX is a market capitalization-weighted index that covers an all-inclusive universe of institutionally traded U.S. Treasury, agency, mortgage, and corporate securities. The index includes all fixed-rate bonds with a maturity of one year or longer. Only issues with at least a $50-million amount outstanding ($200 million for mortgage coupons) can be added to the index, and they remain until their amount outstanding falls below $25 million. Advertisements and other sales literature may quote total returns which are calculated on non-standardized base periods. The total returns represent the historic change in the value of an investment based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Managed Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the prospectus. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. CORPORATE BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. BAA--Bonds which are rated BAA are considered as medium grade obligations, (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATING DEFINITIONS A-1--This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation. A-2--Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1. MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATING DEFINITIONS PRIME-1--Issuers rated Prime-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. PRIME-1 repayment capacity will normally be evidenced by the following characteristics: .Leading market positions in well established industries. .High rates of return on funds employed. .Conservative capitalization structures with moderate reliance on debt and ample asset protection. .Broad margins in earnings coverage of fixed financial charges and high internal cash generation. .Well-established access to a range of financial markets and assured sources of alternate liquidity. PRIME-2--Issuers rated PRIME-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. G00850-15 (2/95) FIRST UNION U.S. GOVERNMENT PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union U.S. Government Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares', Class B Investment Shares' or Class C Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 Asset-Backed Securities 1 Collateralized Mortgage Obligations (CMOs) 1 Section 4(2) Commercial Paper 1 Repurchase Agreements 2 When-Issued and Delayed Delivery Transactions 2 Options and Futures Transactions 2 Lending of Portfolio Securities 4 Restricted Securities 4 Reverse Repurchase Agreements 4 Portfolio Turnover 4 Investment Limitations 5 FIRST UNION FUNDS MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 8 Trustee Compensation 8 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 9 - --------------------------------------------------------------- Adviser to the Fund 9 Advisory Fees 9 BROKERAGE TRANSACTIONS 9 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - --------------------------------------------------------------- PURCHASING SHARES 10 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 11 Shareholder Services Plan 12 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Determining Market Value of Securities 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 12 - --------------------------------------------------------------- The Fund's Tax Status 12 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 13 - --------------------------------------------------------------- FINANCIAL STATEMENTS 14 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union U.S. Government Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The investment objective of the Fund is to provide a high level of current income consistent with stability of principal. TYPES OF INVESTMENTS The Fund invests primarily in securities that are obligations of the U.S. government, its agencies and instrumentalities. Under normal market conditions, at least 65% of the value of the Fund's total assets will be invested in U.S. government securities. This investment policy and the investment objective stated above cannot be changed without approval of shareholders. ASSET-BACKED SECURITIES Credit card receivables are generally unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit laws, many of which give such debtors the right to set off certain amounts owed on the credit cards, thereby reducing the balance due. Most issuers of asset-backed securities backed by automobile receivables permit the servicers of such receivables to retain possession of the underlying obligations. If the servicer were to sell these obligations to another party, there is a risk that the purchaser would acquire an interest superior to that of the holders of the related asset-backed securities. In addition, because of the large number of vehicles involved in a typical issuance and technical requirements under state laws, the trustee for the holders of asset-backed securities backed by automobile receivables may not have a proper security interest in all of the obligations backing such receivables. Therefore, there is the possibility that recoveries on repossessed collateral may not, in some cases, be available to support payments on these securities. In general, issues of asset-backed securities are structured to include additional collateral and/or additional credit support to protect against the risk that a portion of the collateral supporting the asset-backed securities may default and/or may suffer from these defects. In evaluating the strength of particular issues of asset-backed securities, the Fund's adviser considers the financial strength of the guarantor or other provider of credit support, the type and extent of credit enhancement provided as well as the documentation and structure of the issue itself and the credit support. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) Privately issued CMOs generally represent an ownership interest in federal agency mortgage pass-through securities such as those issued by Government National Mortgage Association. The terms and characteristics of the mortgage instruments may vary among pass-through mortgage loan pools. Most of the CMOs in which the Fund would invest use the same basic structure: .Several classes of securities are issued against a pool of mortgage collateral. The most common structure contains four classes of securities: the first three (A, B, and C bonds) pay interest at their stated rates beginning with the issue date; the final class (or Z bond) typically receives the residual income from the underlying investment after payments are made to the other classes. .The cash flows from the underlying mortgages are applied first to pay interest and then to retire securities. .The classes of securities are retired sequentially. All principal payments are directed first to the shortest-maturity class (or A bonds). When those securities are completely retired, all principal payments are then directed to the next-shortest-maturity security (or B bond). This process continues until all of the classes have been paid off. The market for such CMOs has expanded considerably since its inception. The size of the primary issuance market and the active participation in the secondary market by securities dealers and other investors make government-related pools highly liquid. SECTION 4(2) COMMERCIAL PAPER The Fund may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act of 1933. Section 4(2) commercial paper is restricted as to disposition under federal securities law and is generally sold to institutional investors, such as the Fund, who agree that they are purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. Section 4(2) commercial paper is normally resold to other institutional investors like the Fund through or with the assistance of the issuer or investment dealers who make a market in Section 4(2) commercial paper, thus providing liquidity. The Fund believes that Section 4(2) commercial paper and possibly certain other restricted securities which meet the criteria for liquidity established by the Trust's Board of Trustees (the "Trustees") are quite liquid. The Fund intends, therefore, to treat the restricted securities which meet the criteria for liquidity established by the Trustees, including Section 4(2) commercial paper, as determined by the Fund's investment adviser, as liquid and not subject to the investment limitation applicable to illiquid securities. In addition, because Section 4(2) commercial paper is liquid, the Fund does not intend to subject such paper to the limitation applicable to restricted securities. REPURCHASE AGREEMENTS The Fund or its custodian will take possession of the securities subject to repurchase agreements, and these securities will be marked to market daily. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund will only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are deemed by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contacts. Additionally, the Fund may buy and sell call and put options on U.S. government securities. PURCHASING PUT AND CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund would purchase put and call options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the decrease in value of the hedged securities. Alternately, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contact below market price. Prior to the exercise or expiration of the call option, the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. A futures contract held by the Fund is valued daily at the official settlement price on the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and thereby insure that the use of such futures contracts is unleveraged. PURCHASING AND WRITING PUT AND CALL OPTIONS ON U.S. GOVERNMENT SECURITIES The Fund may purchase put and call options on U.S. government securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the buyers or writers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restriction on resale under federal securities laws. The Fund will not invest more than 10% of the value of its total assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 10% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions or resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under the Rule) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. This transaction is similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rates for the Fund were 19% and 39%, respectively. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin but may obtain such short-term credits as may be necessary for the clearance of transactions. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in the securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objectives, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities in accordance with that section of the respective prospectus entitled "Lending of Portfolio Securities." CONCENTRATION OF INVESTMENTS The Fund will not invest 25% or more of the value of its total assets in any one industry. However, investing in U.S. government obligations shall not be considered investments in any one industry. SELLING SHORT The Fund will not sell securities short. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of the Fund's total assets, the Fund will not invest more than 5% of the value of its total assets in any one issuer (except cash and cash items, repurchase agreements, and U.S. government obligations). The Fund will not acquire more than 10% of the outstanding voting securities of any one issuer. Except as noted, the above investment limitations cannot be changed without shareholder approval. The following restrictions, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. RESTRICTED SECURITIES The Fund may invest up to 10% of its total assets in restricted securities. Certain restricted securities which the Trustees deem to be liquid will be excluded from this limitation. The restriction is not applicable to commercial paper issued under Section 4(2) of the Securities Act of 1933. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in portfolio instruments of unseasoned issuers, including their predecessors, that have been in operation for less than three years. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses, such as management fees, and therefore, any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in securities which are illiquid, including repurchase agreements providing for settlement in more than seven days after notice and certain restricted securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary Physician Care 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National, Bank, Charlotte, North Carolina, owned approximately 317,810 Shares (18.79%) and First Union National Bank, Charlotte, North Carolina, owned approximately 1,373,452 Shares (81.21%). As of February 6, 1995, the following shareholder of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Southeastern District-LCMS Church Extension Fund Inc., Alexandria, Virginia, owned approximately 196,582 Shares (7.70%). As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund: FUBS, for the exclusive benefit of Aileen D. Bell and John H. Bell, Hollywood, Florida, owned approximately 3,869 Shares (13.18%); FUBS, for the exclusive benefit of Merle Adair Connell Trust, Winter Garden, Florida, owned approximately 10,834 Shares (36.90%); and FUBS, for the exclusive benefit of Helen G. Bender, Wildwood, Florida, owned approximately 11,037 Shares (37.59%). TRUSTEES COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgement or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Adviser earned $1,355,420 and $802,441, of which $105,523 and $465,195, respectively, were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time, to time use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund paid $10,180 and $0, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $228,590 and $139,691, respectively, in administrative service costs, of which $0 and $30,827, respectively, were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: . quantity discounts and accumulated purchases; . signing a 13-month letter of intent; . using the reinvestment privilege; or . concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A, CLASS B AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B and Class C Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A, Class B and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $79,158 in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $1,683,141 in distribution services fees on behalf of Class B Investment Shares. For the period from September 7, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $313 in distribution services fees on behalf of Class C Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $174,961 and $104 on behalf of Class B Investment Shares and Class C Investment Shares, respectively. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market values of the Fund's portfolio securities, other than options, are determined as follows: .according to prices provided by independent pricing services, which may be determined without exclusive reliance on quoted prices from dealers but which use market prices when most representative, and which may take into account appropriate factors such as yield, quality, coupon rate, maturity, type of issue, trading characteristics, and other market data employed in determining valuations for such securities; or .for short-term obligations with remaining maturities of less than 60 days at the time of purchase, at amortized cost, unless the Trustees determines that particular circumstances of the security indicate otherwise. Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the Exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Y Shares for the one year period ended December 31, 1994, and for the period from August 25, 1993 (start of performance) to December 31, 1994, were (2.94%) and (1.83%), respectively. The Fund's average annual total returns for Class A Investment Shares for the one year period ended December 31, 1994, and for the period from January 12, 1993 (start of performance) to December 31, 1994, were (7.77%) and (0.48%), respectively. The Fund's average annual total returns for Class B Investment Shares for the one year ended December 31, 1994, and for the period from January 12, 1993 (start of performance) to December 31, 1994, were (8.50%) and (0.59%), respectively. The Fund's cumulative total return for Class C Investment Shares for the period from September 2, 1994 (start of performance) to December 31, 1994 was (2.28%). The average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming a monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of Shares redeemed. Cumulative total return reflects Class C Investment Shares' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. Class C Shares total return is representative of only four months of activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Class Y Investment Shares for the thirty-day period ended December 31, 1994 was 7.10%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 6.52%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 6.08%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1994 was 6.08%. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by any class of Shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a 12-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC., ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "U.S. government funds" category in advertising and sales literature. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS INTERMEDIATE GOVERNMENT BOND INDEX is an unmanaged index comprised of all publicly issued, non-convertible domestic debt of the U.S. government or any agency thereof, or any quasi-federal corporation, and of corporate debt guaranteed by the U.S. government. Only notes and bonds with a minimum outstanding principal of $1 million and minimum maturity of one year and maximum maturity of ten years are included. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. From time to time as it deems appropriate, the Fund may advertise the performance of either class of Shares or the performance of the market using charts, graphs, and descriptions, compared to federally insured bank products including certificates of deposit and time deposits and to money market funds using the Lipper Analytical Services money market instruments average. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union U.S. Government Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. G00850-21 (2/95) PROSPECTUS FIRST UNION GROWTH & INCOME FUNDS Y SHARES FEBRUARY 28, 1995 FIRST UNION GROWTH AND INCOME FUNDS Portfolios of First Union Funds Y SHARES - ------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes three diversified Growth and Income Funds, three diversified Income Funds, two diversified Growth Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Y Shares of First Union Growth and Income Funds. It concisely describes the information which you should know before investing in Y Shares of any of the First Union Growth and Income Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Growth and Income Fund in its Statement of Additional Information dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222- 3779 or by calling 1-800-326-2584. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS Summary 2 How to Convert Your Investment from - ------------------------------------- One First Union Fund to Another First Union Fund 22 Summary of Fund Expenses 4 ------------------------------------- - ------------------------------------- How to Redeem Shares 23 Financial Highlights 5 ------------------------------------- - ------------------------------------- Management of First Union Funds 24 Investment Objectives and Policies 10 ------------------------------------- - ------------------------------------- Fees and Expenses 25 First Union Balanced Portfolio 10 ------------------------------------- - ------------------------------------- Shareholder Rights and Privileges 26 First Union Utility Portfolio 11 ------------------------------------- - ------------------------------------- Distributions and Taxes 28 First Union Value Portfolio 13 ------------------------------------- - ------------------------------------- Tax Information 29 Other Investment Policies 15 ------------------------------------- - ------------------------------------- Other Classes of Shares 29 Shareholder Guide 20 ------------------------------------- - ------------------------------------- Shareholder Report 30 How to Buy Shares 21 ------------------------------------- - ------------------------------------- Addresses 31 ------------------------------------- SUMMARY DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Growth and Income Fund is divided into four classes of shares: Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares") and Y Shares. Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). Class A, Class B and Class C Shares are sold to individuals and other customers of First Union (the "Adviser"). This prospectus relates only to Y Shares ("Shares") of First Union Growth and Income Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following three Funds: . First Union Balanced Portfolio ("Balanced Fund")--seeks to produce long-term total return through capital appreciation, dividends, and interest income; . First Union Utility Portfolio ("Utility Fund")--seeks high current income and moderate capital appreciation; and . First Union Value Portfolio ("Value Fund")--seeks long term-capital growth, with current income as a secondary objective. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Y Shares of any of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The market value of fixed income securities, which constitute a major part of the investments of the Funds described in this prospectus, may vary inversely in response to changes in prevailing interest rates. The foreign securities in which the Funds may invest may be subject to certain risks in addition to those inherent in U.S. investments. One or more Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, lending portfolio securities and entering into futures contracts and related options as hedges. These risks and those associated with investing in mortgage-backed securities, when-issued securities, options and variable rate securities are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH AND INCOME FUNDS Y SHARES
Balanced Utility Value Fund Fund Fund -------- ------- ----- Y Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)..................................... None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).......................... None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable).. None None None Redemption Fees (as a percentage of amount redeemed, if applicable)............................................ None None None Exchange Fee............................................ None None None Annual Y Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1)....................... 0.50% 0.00% 0.50% 12b-1 Fees.............................................. None None None Total Other Expenses (after waiver) (2)................. 0.14% 0.58% 0.18% Total Y Shares Operating Expenses (3)................. 0.64% 0.58% 0.68%
(1) The management fee of Utility Fund has been reduced to reflect the voluntary waiver by the Adviser. The Adviser may terminate this voluntary waiver at any time at its sole discretion. The maximum management fee for Utility Fund is 0.50%. (2) Total Other Expenses for Utility Fund are estimated to be 0.85%, absent the voluntary waiver by the Administrator. The Administrator may terminate this voluntary waiver at any time at its sole discretion. (3) Total Y Shares Operating Expenses for Utility Fund were 0.40% for the fiscal year ended December 31, 1994. Total Y Shares Operating Expenses for Utility Fund, absent the voluntary waivers by the Adviser and Administrator, were 1.24% for the fiscal year ended December 31, 1994. The Annual Y Shares Operating Expenses for Utility Fund in the table above are based on expenses expected during the fiscal year ending December 31, 1995. Total Y Shares operating expenses for Utility Fund are expected to be 1.35%, absent the voluntary waivers described above in notes 1 and 2. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees.
EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. As shown above, the Funds charge no redemption fees for Y Shares. Balanced Fund................................ $7 $20 $36 $80 Utility Fund................................. $6 $19 $32 $73 Value Fund................................... $7 $22 $38 $85
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Y Shares of the Funds. The Funds also offer three additional classes of shares, called Class A Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Class A Shares are subject to a 12b-1 fee of 0.25 of 1%. Class B Shares are subject to a 12b-1 fee of 0.75 of 1% and a shareholder service fee of 0.25 of 1%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1% and a shareholder service fee of 0.25 of 1%. In addition, Class A Shares bear a maximum front-end sales load of 4.75%. Class B Shares bear a maximum contingent deferred sales charge of 5.00% and Class C Shares bear a maximum contingent deferred sales charge of 1.00%. See "Fees and Expenses" and "Other Classes of Shares." FINANCIAL HIGHLIGHTS First Union Balanced Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth and Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth and Income Funds' Annual Report, which may be obtained from the Fund.
Class B Investment Y Shares Class A Investment Shares Shares ------------------------------------ -------------------------------------- ------------------ Year Ended Year Ended December 31, Year Ended December 31, December 31, ------------------------------------ -------------------------------------- ------------------ 1994 1993 1992 1991** 1994 1993 1992 1991*** 1994 1993**** - ---------------- -------- -------- -------- -------- ------- ------- ------- ------- -------- -------- Net asset value, beginning of pe- riod $12.07 $11.41 $11.02 $10.00 $12.07 $11.41 $11.02 $10.00 $12.08 $11.54 - ---------------- Income from investment operations - ---------------- Net investment income 0.46 0.45 0.46 0.36 0.43 0.419 0.42 0.30 0.36 0.34 - ---------------- Net realized and unrealized gain (loss) on investments (0.71) 0.75 0.42 1.03 (0.71) 0.755 0.43 1.08 (0.71) 0.65 - ---------------- ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ Total from investment operations (0.25) 1.20 0.88 1.39 (0.28) 1.174 0.85 1.38 (0.35) 0.99 - ---------------- Less distribu- tions - ---------------- Dividends to shareholders from net investment income (0.46) (0.45) (0.45) (0.36) (0.43) (0.419) (0.42) (0.35) (0.36) (0.34) - ---------------- Distributions to shareholders from net realized gain on investment transactions (0.19) (0.09) (0.04) (0.01) (0.19) (0.091) (0.04) (0.01) (0.19) (0.09) - ---------------- Distributions in excess of net investment income -- -- -- -- -- (0.004)(a) -- -- -- (0.02)(a) - ---------------- ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ Total distribu- tions (0.65) (0.54) (0.49) (0.37) (0.62) (0.514) (0.46) (0.36) (0.55) (0.45) - ---------------- ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ Net asset value, end of period $11.17 $12.07 $11.41 $11.02 $11.17 $12.07 $11.41 $11.02 $11.18 $12.08 - ---------------- ------ ------ ------ ------ ------ ------- ------ ------ ------ ------ Total return+ (2.15%) 10.68% 8.21% 15.02% (2.41%) 10.41% 7.94% 11.75% (2.99%) 8.72% - ---------------- Ratios to Aver- age Net Assets - ---------------- Expenses 0.64% 0.66% 0.66% 0.68%(b) 0.89% 0.91% 0.91% 0.92%(b) 1.48% 1.41%(b) - ---------------- Net investment income 3.94% 3.86% 4.20% 4.86%(b) 3.69% 3.61% 3.93% 4.38%(b) 3.12% 3.09%(b) - ---------------- Supplemental Data - ---------------- Net assets, end of period (000 omitted) $778,657 $760,147 $520,232 $247,472 $41,010 $35,032 $17,408 $334 $100,052 $65,475 - ---------------- Portfolio turnover rate 35% 19% 12% 19% 35% 19% 12% 19% 35% 19% - ---------------- Class C Investment Shares ------------- Year Ended December 31, ------------- 1994* - ----------------- ------------- Net asset value, beginning of pe- riod $12.00 - ----------------- Income from investment operations - ----------------- Net investment income 0.18 - ----------------- Net realized and unrealized gain (loss) on investments (0.61) - ----------------- ------------- Total from investment operations (0.43) - ----------------- Less distribu- tions - ----------------- Dividends to shareholders from net investment income (0.21) - ----------------- Distributions to shareholders from net realized gain on investment transactions (0.19) - ----------------- Distributions in excess of net investment income -- - ----------------- ------------- Total distribu- tions (0.40) - ----------------- ------------- Net asset value, end of period $11.17 - ----------------- ------------- Total return+ (3.58%) - ----------------- Ratios to Aver- age Net Assets - ----------------- Expenses 1.64%(b) - ----------------- Net investment income 3.23%(b) - ----------------- Supplemental Data - ----------------- Net assets, end of period (000 omitted) $195 - ----------------- Portfolio turnover rate 35% - -----------------
*Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. **Reflects operations for the period from April 1, 1991 (commencement of operations) to December 31, 1991. ***Reflects operations for the period from June 10, 1991 (commencement of operations) to December 31, 1991. **** Reflects operations for the period from January 26, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Distributions in excess of net investment income for the year ended December 31, 1993 were the result of certain book and tax differences. These differences did not represent a return of capital for federal income tax purposes for the year ended December 31, 1993. (b) Computed on an annualized basis. Further information about Fund's performance is contained in the Growth and Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS First Union Utility Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth and Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth and Income Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Y Investment Investment Investment Shares Shares Shares Shares ------------ ------------ ------------ ------------ Year Ended Year Ended Year Ended Year Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994** 1994** 1994*** - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $ 9.51 $10.00 $10.00 $ 9.33 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.37 0.45 0.39 0.12 - ------------------------ Net realized and unrealized gain (loss) on investments (0.50) (1.01) (1.01) (0.33) - ------------------------ ------ ------ ------ ------ Total from investment operations (0.13) (0.56) (0.62) (0.21) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.37) (0.44) (0.38) (0.11) - ------------------------ Distributions in excess of net investment in- come (0.01)(c) -- -- -- - ------------------------ ------ ------ ------ ------ Total distributions (0.38) (0.44) (0.38) (0.11) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.00 $ 9.00 $ 9.00 $ 9.01 - ------------------------ ------ ------ ------ ------ Total return+ (1.55%) (5.60%) (6.24%) (2.22%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.40%(b) 0.53%(b) 1.27%(b) 1.94%(b) - ------------------------ Net investment income 4.93%(b) 5.07%(b) 4.19%(b) 3.96%(b) - ------------------------ Expense waiver/reimbursement (a) 0.84%(b) 0.90%(b) 0.84%(b) 0.84%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $5,201 $4,190 $28,792 $128 - ------------------------ Portfolio turnover rate 23% 23% 23% 23% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from January 4, 1994 (commencement of operations) to December 31, 1994. *** Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. These distributions do not represent a return of capital for federal income tax purposes. Further information about Fund's performance is contained in the Growth and Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS First Union Value Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth and Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth and Income Funds' Annual Report, which may be obtained from the Fund.
Y Shares --------------------------------------- Year Ended December 31, --------------------------------------- 1994 1993 1992 1991* - ----------------------------------- -------- -------- -------- -------- Net asset value, beginning of pe- riod $17.63 $17.11 $17.08 $14.28 - ----------------------------------- Income from investment operations - ----------------------------------- Net investment income 0.56 0.52 0.49 0.47 - ----------------------------------- Net realized and unrealized gain (loss) on investments (0.20) 1.12 0.90 3.53 - ----------------------------------- ------ ------ ------- ------ Total from investment operations 0.36 1.64 1.39 4.00 - ----------------------------------- Less distributions - ----------------------------------- Dividends to shareholders from net investment income (0.56) (0.52) (0.49) (0.47) - ----------------------------------- Distributions to shareholders from net realized gain on investment transactions (0.82) (0.58) (0.87) (0.73) - ----------------------------------- Distributions in excess of net in- vestment income -- (0.02)(c) -- -- - ----------------------------------- ------ ------ ------- ------ Total distributions (1.38) (1.12) (1.36) (1.20) - ----------------------------------- ------ ------ ------- ------ Net asset value, end of period $16.61 $17.63 $17.11 $17.08 - ----------------------------------- ------ ------ ------- ------ Total return+ 2.07% 9.71% 8.31% 25.41% - ----------------------------------- Ratios to Average Net Assets - ----------------------------------- Expenses 0.68% 0.65% 0.68% 0.69%(b) - ----------------------------------- Net investment income 3.21% 2.98% 2.90% 3.04%(b) - ----------------------------------- Expense waiver/reimbursement (a) -- -- 0.01% 0.08%(b) - ----------------------------------- Supplemental Data - ----------------------------------- Net assets, end of period (000 omitted) $507,028 $463,087 $326,154 $271,391 - ----------------------------------- Portfolio turnover rate 70% 46% 56% 69% - -----------------------------------
* Reflects operations for the period from January 3, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the period ended December 31, 1993 were the result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1993. Further information about Fund's performance is contained in the Growth and Income Funds' Annual Report, ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS (continued) First Union Value Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth and Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth and Income Funds' Annual Report, which may be obtained from the Fund.
Class A Investment Shares --------------------------------------------------------------------------------------------------- Year Ended December 31, Year Ended March 31, -------------------------------------------- --------------------------------------------------- 1994 1993 1992 1991 1990* 1990 1989 1988 1987 1986 1985** - ----------------------- -------- -------- -------- -------- -------- ------- ------- ------- ------- ------ ------ Net asset value, beginning of period $17.63 $17.11 $17.08 $14.61 $15.12 $14.45 $12.83 $14.66 $12.35 $10.04 $10.00 - ----------------------- Income from investment operations - ----------------------- Net investment income 0.52 0.47 0.44 0.46 0.36 0.54 0.36 0.26 0.15 0.19 0.04 - ----------------------- Net realized and unrealized gain (loss) on investments (0.20) 1.10 0.89 3.17 (0.44) 1.70 2.11 (1.30) 2.38 2.32 0.00 - ----------------------- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations 0.32 1.57 1.33 3.63 (0.08) 2.24 2.47 (1.04) 2.53 2.51 0.04 - ----------------------- Less distributions - ----------------------- Dividends to shareholders from net investment income (0.51) (0.47) (0.43) (0.43) (0.36) (0.57) (0.38) (0.26) (0.13) (0.20) -- - ----------------------- Distributions to shareholders from net realized gain on investment transactions (0.82) (0.58) (0.87) (0.73) (0.02) (1.00) (0.47) (0.53) (0.09) -- -- - ----------------------- Distributions in excess of net investment income -- -- -- -- (0.05)(c) -- -- -- -- -- -- - ----------------------- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total distributions (1.33) (1.05) (1.30) (1.16) (0.43) (1.57) (0.85) (0.79) (0.22) (0.20) 0.00 - ----------------------- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $16.62 $17.63 $17.11 $17.08 $14.61 $15.12 $14.45 $12.83 $14.66 $12.35 $10.04 - ----------------------- ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total return+ 1.86% 9.31% 7.96% 25.11% (0.51%) 15.54% 19.73% (7.14%) 20.81% 25.29% (0.40%) - ----------------------- Ratios to Average Net Assets - ----------------------- Expenses 0.93% 0.99% 1.01% 0.96% 1.39%(b) 1.55% 1.71% 1.74% 1.97% 2.00% 2.00%(b) - ----------------------- Net investment income 2.96% 2.63% 2.37% 2.78% 3.28%(b) 3.42% 2.72% 1.92% 1.41% 2.34% 6.47%(b) - ----------------------- Expense waiver/ reimbursement(a) -- -- 0.01% 0.09% -- -- -- -- -- -- -- - ----------------------- Supplemental Data - ----------------------- Net assets, end of period (000 omitted) $188,807 $189,983 $169,310 $135,565 $104,637 $95,995 $83,121 $21,914 $23,221 $5,595 $100 - ----------------------- Portfolio turnover rate++ 70% 46% 56% 69% 13% 11% 24% 24% 20% 20% 0% - -----------------------
*For the nine months ended December 31, 1990. ** Reflects operations for the period from August 30, 1984 (commencement of operations) to March 31, 1985. +Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. ++ Portfolio turnover rate for periods ending on or after March 31, 1986 include certain U.S. government obligations. (a) This voluntary expense decrease is reflected in both the expense and net investment ratios shown above. (b) Computed on an annualized basis. (c) Distributions in excess of net investment income for the period ended December 31, 1990 were a result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1990. Further information about Fund's performance is contained in the Growth and Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS (continued) First Union Value Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Funds' independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth and Income Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth and Income Funds' Annual Report, which may be obtained from the Fund.
Class C Class B Investment Investment Shares Shares ------------------ ------------ Year Ended Year Ended December 31, December 31, ------------------ ------------ 1994 1993** 1994* - ------------------------------------------ --------- -------- ------------ Net asset value, beginning of period $17.63 $17.24 $18.28 - ------------------------------------------ Income from investment operations - ------------------------------------------ Net investment income 0.42 0.35 0.19 - ------------------------------------------ Net realized and unrealized gain (loss) on investments (0.20) 1.01 (0.81) - ------------------------------------------ ------- ------ ------ Total from investment operations 0.22 1.36 (0.62) - ------------------------------------------ Less distributions - ------------------------------------------ Dividends to shareholders from net in- vestment income (0.41) (0.35) (0.19) - ------------------------------------------ Distributions to shareholders from net realized gain on investment transactions (0.82) (0.58) (0.82) - ------------------------------------------ Distributions in excess of net investment income -- (0.04)(b) (0.04)(b) - ------------------------------------------ ------- ------ ------ Total distributions (1.23) (0.97) (1.05) - ------------------------------------------ ------- ------ ------ Net asset value, end of period $16.62 $17.63 $16.61 - ------------------------------------------ ------- ------ ------ Total return+ 1.26% 7.98% (3.41%) - ------------------------------------------ Ratios to Average Net Assets - ------------------------------------------ Expenses 1.53% 1.48%(a) 1.68%(a) - ------------------------------------------ Net investment income 2.36% 2.09%(a) 2.16%(a) - ------------------------------------------ Supplemental Data - ------------------------------------------ Net assets, end of period (000 omitted) $104,297 $59,953 $485 - ------------------------------------------ Portfolio turnover rate 70% 46% 70% - ------------------------------------------
* Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from February 2, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) Distributions in excess of net investment income, for the Class B Investment Shares, for the period ended December 31, 1993 and for the Class C Investment Shares, for the period ended December 31, 1994, were the result of certain book and tax timing differences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1993 and December 31, 1994. Further information about Fund's performance is contained in the Growth and Income Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES AND POLICIES First Union Growth and Income Funds provide a broad range of objectives and policies, intended to offer investment alternatives to a large group of investors with a wide range of investment objectives. The investment objectives and policies of each Fund are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION BALANCED PORTFOLIO Objective: Long-term total return through capital appreciation, dividends, and interest income. Invests in: Common and preferred stocks for growth, bonds for stable income flows. Suitable for: Investors looking for long-term growth of income and capital from a portfolio of equity and fixed income investments. Key Benefit: Diversity of investments takes advantage of shifts in market conditions and relative attractiveness of different types of securities. DESCRIPTION OF THE FUND The Balanced Fund seeks long-term total return through capital appreciation, dividends, and interest income. The Fund invests primarily in a diversified portfolio of common and preferred stocks, U.S. government securities, high grade corporate bonds, and money market instruments. Common and preferred stocks are utilized for growth while bonds provide stable income flows. The portion of the Fund's total assets invested in common and preferred stocks will vary according to the Adviser's assessment of market and economic conditions and outlook. The asset mix of the Fund will normally range between 40-75% common and preferred stocks, 25-50% fixed income securities (including some convertible securities), and 0-25% money market instruments. Moderate shifts between types of assets are made in order to maximize returns or reduce risk. Over the long-term, it is anticipated that the Fund's asset mix will average 60% in common and preferred stocks and 40% in bonds. TYPES OF INVESTMENTS The Fund invests in common, preferred and convertible preferred stocks and bonds of U.S. companies with at least $100 million in equity, listed on major stock exchanges or traded over-the-counter. The Fund looks at financial strength (such as cash flow and low debt-to-equity ratio), earnings growth and price in relation to current earnings, dividends, and book value to identify growth opportunities. The Fund may also invest in American Depositary Receipts ("ADRs") of foreign companies traded on the New York or American Stock Exchanges or in the over- the-counter market. The Fund will only invest in those bonds, including convertible bonds, which are rated A or higher by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group ("S&P"), or which, if unrated, are considered to be of comparable quality by the Adviser. Bonds are selected based on the outlook for interest rates and their yield in relation to other bonds of similar quality and maturity. Bond maturities in the portfolio average less than twenty years. The Fund also invests in securities which are either issued or guaranteed by the U.S. government, its agencies, or instrumentalities. These types of securities include: direct obligations of the U.S. Treasury, such as U.S. Treasury bills, notes and bonds; and notes, bonds, and discount notes of U.S. government agencies or instrumentalities, such as the: Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks, and Banks for Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal Home Loan Mortgage Corporation; Federal National Mortgage Association; Government National Mortgage Association; Student Loan Marketing Association; Tennessee Valley Authority; Export-Import Bank of the United States; Commodity Credit Corporation; Federal Financing Bank; and National Credit Union Administration. Some U.S. government agency obligations are backed by the full faith and credit of the U.S. Treasury. Others in which the Fund may invest are supported by: the issuer's right to borrow an amount limited to a specific line of credit from the U.S. Treasury; discretionary authority of the U.S. government to purchase certain obligations of an agency or instrumentality; or the credit of the agency or instrumentality. The Fund may invest short-term in money market instruments; securities issued and/or guaranteed by the U.S. government, its agencies, or instrumentalities; and repurchase agreements collateralized by eligible investments. FIRST UNION UTILITY PORTFOLIO Objective: High current income and moderate capital appreciation. Invests in: Equity and debt securities of utility companies. Suitable for: Investors seeking current income and long-term growth of income through equity and fixed income investments in utility companies. Key Benefit: Diversity through historically reliable cash flows on securities that typically hold their value through various market conditions. DESCRIPTION OF THE FUND The Utility Fund seeks high current income and moderate capital appreciation. The Fund invests primarily in a diversified portfolio of equity and debt securities of utility companies that produce, transmit or distribute gas or electrical energy, as well as those companies that provide communications facilities, such as telephone and telegraph companies. As a matter of investment policy, the Fund will invest at least 65% of the value of its total assets in utility companies that derive 50% of their revenues from utilities or assets relating to utility industries. In addition, the Fund can invest up to 35% of its assets in common stock of non-utility companies. TYPES OF INVESTMENTS The Fund may invest in: common and preferred stocks, bonds and convertible preferred stocks of utility companies selected by the Adviser on the basis of traditional research techniques, including assessment of earnings and dividend growth prospects and of the risk and volatility of the individual company's industry. However, other factors, such as product position, market share, or profitability may also be considered by the Adviser. The Fund will only invest its assets in debt securities rated Baa or higher by Moody's or BBB or higher by S&P, or which, if unrated, are considered to be of comparable quality by the Adviser; securities either issued or guaranteed by the U.S. government, its agencies, or instrumentalities, as described under the caption "First Union Balanced Portfolio--Types of Investments;" commercial paper, including master demand notes; ADRs of foreign companies traded on the New York or American Stock Exchanges or in the over-the-counter market; foreign securities (either foreign or U.S. securities traded in foreign markets). The Fund may also invest in other obligations denominated in foreign currencies. In making these decisions, the Adviser will consider such factors as the condition and growth potential of various economies and securities markets, currency and taxation considerations and other pertinent financial, social, national and political factors. (See "Other Investment Policies" and "Foreign Investments.") The Fund will not invest more than 10% of its assets in foreign securities; obligations, including certificates of deposit and bankers' acceptances, of banks or savings and loan associations having at least $1 billion in deposits and insured by the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF"), including U.S. branches of foreign banks and foreign branches of U.S. banks; securities of other investment companies; and repurchase agreements collateralized by government securities. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. RISK FACTORS In view of the Fund's investment concentration, investors should be aware of certain risks associated with the utility industry in general. These include difficulties in earning adequate returns on investments despite frequent rate increases, restrictions on operations and increased costs and delays due to governmental regulations, building or construction delays, environmental regulations, difficulty of the capital markets in absorbing utility debt and equity securities, and difficulties in obtaining fuel at reasonable prices. The Adviser believes that the risks of investing in utility securities can be reduced. The professional portfolio management techniques used by the Adviser to attempt to reduce these risks include credit research. The Adviser will perform its own credit analysis, in addition to using recognized rating agencies and other sources, including discussions with an issuer's management, the judgment of other investment analysts, and its own informed judgment. The Adviser's credit analysis will consider an issuer's financial soundness, its responsiveness to changes in interest rates and business conditions, its anticipated cash flow, interest or dividend coverage, and earnings. In evaluating an issuer, the Adviser places special emphasis on the estimated current value of the issuer's assets rather than historical costs. Bond prices move inversely to interest rates, i.e. as interest rates decline, the values of the bonds increase and vice versa. The longer the maturity of a bond, the greater the exposure to market price fluctuations. The same market factors are reflected in the share price or net asset value of bond funds which will vary with interest rates. There is no limit on the maturity of the fixed income securities purchased by the Fund. FIRST UNION VALUE PORTFOLIO Objective: Long-term capital growth with current income as a secondary objective. Invests in: Equity securities of U.S. companies with prospects for growth in earnings and dividends. Suitable for: Long-term investors seeking capital appreciation with some income. Key Benefit: Allows accumulation of assets over the long-term through capital appreciation of equity investments and reinvestment of dividends. DESCRIPTION OF THE FUND The Value Fund seeks long-term capital growth with current income as a secondary objective. The Fund normally invests at least 75% of its assets in equity securities of U.S. companies with prospects for growth in earnings and dividends. TYPES OF INVESTMENTS: The Fund primarily invests in: common and preferred stocks, bonds and convertible preferred stock of U.S. companies with at least $100 million in equity, listed on the New York or American Stock Exchanges or traded in over-the-counter markets. The Adviser looks for industries and companies which have potential primarily for capital growth and secondarily for income; ADRs of foreign companies traded on the New York or American Stock Exchanges or in the over-the-counter market; foreign securities (either foreign or U.S. securities traded in foreign markets). The Fund may also invest in obligations denominated in foreign currencies. In making these decisions, the Adviser will consider such factors as the condition and growth potential of various economies and securities markets, currency and taxation considerations and other pertinent financial, social, national and political factors. (See "Other Investment Policies" and "Foreign Investments."); convertible bonds rated at least BBB by S&P or at least Baa by Moody's, or, if not rated, determined to be of comparable quality by the Adviser; money market instruments; fixed rate notes and bonds and adjustable and variable rate notes of companies whose common stock the Fund may acquire rated at least BBB by S&P or at least Baa by Moody's, or which, if not rated, determined to be of comparable quality by the Adviser (up to 5% of its net assets); zero coupon bonds issued or guaranteed by the U.S. government, its agencies or instrumentalities (up to 5% of its net assets); obligations, including certificates of deposit and bankers' acceptances, of banks or savings and loan associations having at least $1 billion in deposits and insured by the BIF or the SAIF, including U.S. branches of foreign banks and foreign branches of U.S. banks; prime commercial paper, including master demand notes; and repurchase agreements collateralized by eligible investments. Bonds rated BBB by S&P or Baa by Moody's have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. OTHER INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. DOWNGRADES If any security invested in by any of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Fund's risk is the inability of the seller to pay the agreed-upon price on delivery date. However, this risk is tempered by the ability of the Fund to sell the security in the open market in the case of a default. In such a case, the Fund may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which a Fund purchases securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause a Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, a Fund may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, the Funds will not lend any of their assets except portfolio securities up to 5% (in the case of the Balanced and Value Funds) or 15% (in the case of the Utility Fund) of the value of their respective total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. OPTIONS AND FUTURES All of the Funds may engage in options and futures transactions. Options and futures transactions are intended to enable a Fund to manage market, interest rate or exchange rate risk, and the Funds do not use these transactions for speculation or leverage. The Funds may attempt to hedge all or a portion of their portfolios through the purchase of both put and call options on their portfolio securities and listed put options on financial futures contracts for portfolio securities. The Funds may also write covered call options on their portfolio securities to attempt to increase their current income. The Funds will maintain their positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. The Funds may purchase listed put options on financial futures contracts. These options will be used only to protect portfolio securities against decreases in value resulting from market factors such as an anticipated increase in interest rates. The Funds may write (i.e., sell) covered call and put options. By writing a call option, a Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price. By writing a put option, a Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. The Funds also may write straddles (combinations of covered puts and calls on the same underlying security). The Funds may only write "covered" options. This means that so long as a Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. A Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of the put option, it deposits and maintains with its custodian in a segregated account liquid assets having a value equal to or greater than the exercise price of the option. The principal reason for writing call or put options is to obtain, through a receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Funds receive a premium from writing a call or put option which they retain whether or not the option is exercised. By writing a call option, the Funds might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Funds might become obligated to purchase the underlying securities for more than their current market price upon exercise. A futures contract is a firm commitment by two parties: the seller, who agrees to make delivery of the specific type of instrument called for in the contract ("going short"), and the buyer, who agrees to take delivery of the instrument ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt instruments issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. If a Fund would enter into financial futures contracts directly to hedge its holdings of fixed income securities, it would enter into contracts to deliver securities at an undetermined price (i.e., "go short") to protect itself against the possibility that the prices of its fixed income securities may decline during the Fund's anticipated holding period. A Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. The Funds may also enter into currency and other financial futures contracts and write options on such contracts. The Funds intend to enter into such contracts and related options for hedging purposes. The Funds will enter into futures on securities, currencies, or index-based futures contracts in order to hedge against changes in interest or exchange rates or securities prices. A futures contract on securities or currencies is an agreement to buy or sell securities or currencies during a designated month at whatever price exists at that time. A futures contract on a securities index does not involve the actual delivery of securities, but merely requires the payment of a cash settlement based on changes in the securities index. The Funds do not make payment or deliver securities upon entering into a futures contract. Instead, they put down a margin deposit, which is adjusted to reflect changes in the value of the contract and which remains in effect until the contract is terminated. The Funds may sell or purchase currency and other financial futures contracts. When a futures contract is sold by a Fund, the profit on the contract will tend to rise when the value of the underlying securities or currencies declines and to fall when the value of such securities or currencies increases. Thus, the Funds sell futures contracts in order to offset a possible decline in the profit on their securities or currencies. If a futures contract is purchased by a Fund, the value of the contract will tend to rise when the value of the underlying securities or currencies increases and to fall when the value or such securities or currencies declines. The Funds may enter into closing purchase and sale transactions in order to terminate a futures contract and may buy or sell put and call options for the purpose of closing out their options positions. The Funds' ability to enter into closing transactions depends on the development and maintenance of a liquid secondary market. There is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. As a result, there can be no assurance that the Funds will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Funds are not able to enter into an offsetting transaction, the Funds will continue to be required to maintain the margin deposits on the contract and to complete the contract according to its terms, in which case the Funds would continue to bear market risk on the transaction. RISK CHARACTERISTICS OF OPTIONS AND FUTURES Although options and futures transactions are intended to enable the Funds to manage market, exchange, or interest rate risks, these investment devices can be highly volatile, and the Funds' use of them can result in poorer performance (i.e., the Funds' returns may be reduced). The Funds' attempt to use such investment devices for hedging purposes may not be successful. Successful futures strategies require the ability to predict future movements in securities prices, interest rates and other economic factors. When the Funds use financial futures contracts and options on financial futures contracts as hedging devices, there is a risk that the prices of the securities subject to the financial futures contracts and options on financial futures contracts may not correlate perfectly with the prices of the securities in the Funds' portfolios. This may cause the financial futures contract and any related options to react to market changes differently than the portfolio securities. In addition, the Adviser could be incorrect in its expectations and forecasts about the direction or extent of market factors, such as interest rates, securities price movements, and other economic factors. Even if the Adviser correctly predicts interest rate movements, a hedge could be unsuccessful if changes in the value of a Fund's futures position did not correspond to changes in the value of its investments. In these events, the Funds may lose money on the financial futures contracts or the options on financial futures contracts. It is not certain that a secondary market for positions in financial futures contracts or for options on financial futures contracts will exist at all times. Although the Adviser will consider liquidity before entering into financial futures contracts or options on financial futures contracts transactions, there is no assurance that a liquid secondary market on an exchange will exist for any particular financial futures contract or option on a financial futures contract at any particular time. The Funds' ability to establish and close out financial futures contracts and options on financial futures contract positions depends on this secondary market. If a Fund is unable to close out its position due to disruptions in the market or lack of liquidity, the Fund may lose money on the futures contract or option, and the losses to the Fund could be significant. FOREIGN INVESTMENTS The Funds may invest in foreign securities or securities denominated in or indexed to foreign currencies. These may involve additional risks. Specifically, they may be affected by the strength of foreign currencies relative to the U.S. dollar, or by political or economic developments in foreign countries. Accounting procedures and government supervision may be less stringent than those applicable to U.S. companies. There may be less publicly available information about a foreign company than about a U.S. company. Foreign markets may be less liquid or more volatile than U.S. markets and may offer less protection to investors. It may also be more difficult to enforce contractual obligations abroad than would be the case in the United States because of differences in the legal systems. Foreign securities may be subject to foreign taxes, which may reduce yield, and may be less marketable than comparable U.S. securities. All these factors are considered by the Adviser before making any of these types of investments. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies that have investment objectives and policies similar to its own. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) no Fund will own more than 3% of the total outstanding voting stock of any one investment company, (2) no Fund may invest more than 5% of its total assets in any one investment company and (3) no Fund may invest more than 10% of its total assets in investment companies in general. The Adviser will waive its investment advisory fee on assets invested in securities of other open-end investment companies. RESTRICTED AND ILLIQUID SECURITIES The Funds may invest up to 10% of their net assets in securities which are subject to restrictions on resale under federal securities law. The Balanced and Value Funds may invest up to 10% of their net assets in illiquid securities. The Utility Fund may invest up to 15% of its net assets in illiquid securities. With respect to the Balanced and Utility Funds, illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. With respect to the Value Fund, illiquid securities include repurchase agreements providing for settlement in more than seven days after notice and certain restricted securities. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one-third of the value of its total assets and pledge up to 10% (in the case of Value Fund) and 15% (in the case of the Balanced and Utility Funds) of the value of those assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of its total assets, no Fund may invest more than 5% of its total assets in securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. CONCENTRATION OF INVESTMENTS The Utility Fund will not purchase any security of any issuer if, as a result, more than 25% of its total assets would be invested in any one industry other than the utilities industry, except that the Fund may invest more than 25% of the value of its total assets in securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities. SELLING SHORT The Balanced Fund will not make short sales of securities, except in certain limited circumstances. Certain of the Funds have adopted the following investment limitations, which may be changed by the Trustees without shareholder approval. NEW ISSUERS The Balanced Fund will not invest more than 5% of the value of its total assets in securities of issuers (or guarantors, where applicable) which have records of less than three years of continuous operations, including the operation of any predecessor. WARRANTS The Balanced and Value Funds may not invest more than 5% of their net assets in warrants. No more than 2% of this 5% may be in warrants which are not listed on the New York or American Stock Exchanges. SHAREHOLDER GUIDE SHARE PRICE CALCULATION In the case of no-load Funds, the net asset value, the market price and the offering price of Shares are all the same. Purchases, redemptions, and exchanges are made at net asset value. The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of Shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Y Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yield of Y Shares is calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Y Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return and yield will be calculated separately for Y Shares, Class A Shares, Class B Shares and Class C Shares of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee, and Class B Shares and Class C Shares are subject to a Rule 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the contingent deferred sales charge ("CDSC"), which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There are no sales charges imposed on Y Shares of the Funds. However, there is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Capital Management Group of First Union at1- 800-326-2584. Subsequent investments may be in any amounts. BY TELEPHONE You may purchase Y Shares by telephone from the Capital Management Group of First Union at 1-800-326-2584. (Texas residents should directly contact the Mutual Funds Group of First Union Brokerage Services, Inc. at 1-800-326-3241.) Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. Purchase orders must be received by 4:00 p.m. (Eastern time). Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call First Union at 1-800-326-2584 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Y Shares of one First Union Fund for Y Shares of any other First Union Fund by calling toll free 1-800-326-2584 or by writing to First Union. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any fees. You may redeem Shares in person or by telephoning First Union at 1-800-326- 2584 or by written request to First Union. There is no redemption fee charged. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. MANAGEMENT OF FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. R. Dean Hawes is a Vice President of First Union National Bank of North Carolina, N.A., and is the Director of Employee Benefit Portfolio Management. Mr. Hawes joined First Union in 1981 after spending five years with Merrill Lynch, Pierce, Fenner, & Smith and Townsend Investments. Mr. Hawes has served as the portfolio manager of the Balanced Fund since its inception in January 1991. H. Bradley Donovan is an Assistant Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1992. Prior to that, Mr. Donovan had served as a portfolio manager & equity analyst at The Bank of Boston. Mr. Donovan has served as the portfolio manager of the Utility Fund since July 1994. William T. Davis, Jr. is a Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1986. Prior to that, Mr. Davis served as a securities analyst for Seibels Bruce (Insurance) Group. Mr. Davis has served as the portfolio manager of the Value Fund since March 1991. FUND ADMINISTRATION Federated Securities Corp., Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.50 of 1% of each of the Growth and Income Fund's average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below:
Maximum Average Aggregate Daily Administrative Fee Net Assets of the Trust ------------------ ----------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million
Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND Y SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal, and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank of Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 67,604,537 shares (98.44%) of Balanced Fund Y Shares; and First Union Brokerage Service, for the exclusive benefit of Naomi Hamuy of Coral Springs, Florida, was the owner of record of approximately 8,864 shares (49.20%) of Balanced Fund Class C Investment Shares, and therefore may, for certain purposes, be deemed to control the Balanced Fund and be able to affect the outcome of certain matters presented for a vote of shareholders. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 563,915 shares (97.41%) of Utility Fund-Y Shares; and First Union Brokerage Service, for the exclusive benefit of Elsie and Lewis Strom, both of Bennettsville, South Carolina, was the owner of record of approximately 5,470 shares (38.00%) of Utility Fund Class C Investment Shares, and therefore may, for certain purposes, be deemed to control the Utility Fund and be able to affect the outcome of certain matters presented for a vote of shareholders. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 25,570,079 shares (90.57%) of Value Fund-Y Shares, and therefore may, for certain purposes, be deemed to control the Value Fund and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required, by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid quarterly for the Value and Balanced Funds, and dividends are declared and paid monthly for the Utility Fund. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex- dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or First Union in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX INFORMATION Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. All shareholders, unless otherwise exempt, are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES OF SHARES First Union Growth and Income Funds offer four classes of shares: Y Shares for institutional investors, and Class A Shares, Class B Shares and Class C Shares for individuals and other customers of First Union. Class A Shares, Class B Shares and Class C Shares are sold to customers of First Union and others at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B Shares and Class C Shares). Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non-qualified employee benefit and savings plans which make Shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount equal to up to 0.50 of 1% of the net asset value of Class A Shares purchased. These payments are subject to reclaim in the event Class A Shares are redeemed within 12 months after purchase. Class A Shares, Class B Shares and Class C Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of 0.25 of 1% for Class A Shares and 0.75 of 1% for Class B Shares and Class C Shares of each Fund's average daily net asset value. In addition, Class B Shares and Class C Shares pay a shareholder services fee of 0.25 of 1% of the respective class's average daily net assets. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares, and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either contact the Capital Management Group of First Union at 1-800-326-2584, or write the Trust. ADDRESSES - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor 535678 (10/pkg.) G00850-08 (2/95) PROSPECTUS FIRST UNION GROWTH FUNDS CLASS A, B, AND C INVESTMENT SHARES FEBRUARY 28, 1995 [LOGO] FIRST UNION GROWTH FUNDS Portfolios of First Union Funds CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes two diversified Growth Funds, three diversified Growth and Income Funds, three diversified Income Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), and Class C Investment Shares ("Class C Shares") (collectively referred to as "Investment Shares") of First Union Growth Funds. It concisely describes the information which you should know before investing in Class A Shares, Class B Shares or Class C Shares of either of the First Union Growth Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Growth Fund in the Combined Statement of Additional Information, dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statement is available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-3241. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - -------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS Summary 2 How to Redeem Shares 20 - -------------------------------------- -------------------------------------- Summary of Fund Expenses 4 Additional Shareholder Services 20 - -------------------------------------- -------------------------------------- Financial Highlights 7 Management of First Union Funds 21 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 9 Fees and Expenses 24 - -------------------------------------- -------------------------------------- First Union Emerging Markets Growth Shareholder Rights and Privileges 25 Portfolio 9 -------------------------------------- - -------------------------------------- Distributions and Taxes 27 First Union International Equity -------------------------------------- Portfolio 9 - -------------------------------------- Tax Information 27 -------------------------------------- Types of Investments 10 - -------------------------------------- Other Classes of Shares 27 -------------------------------------- Other Investment Policies 10 - -------------------------------------- Shareholder Reports 28 -------------------------------------- Shareholder Guide 15 - -------------------------------------- Addresses 29 -------------------------------------- How to Buy Shares 16 - -------------------------------------- How to Convert Your Investment from One First Union Fund to Another First Union Fund 19 - -------------------------------------- SUMMARY DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Growth Fund is divided into four classes of shares: Class A Shares, Class B Shares, Class C Shares and Y Shares. Class A, Class B, and Class C Shares are sold to individuals and other customers of First Union (the "Adviser") or its affiliates and are sold at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B and Class C Shares). Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates to all three classes of Investment Shares ("Shares") of First Union Growth Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Class A, Class B, and Class C Shares are offered in the following two Funds: . First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund")--seeks to provide long-term capital appreciation. The Emerging Markets Growth Fund invests in equity securities of issuers located in countries with emerging markets; and . First Union International Equity Portfolio ("International Equity Fund")-- seeks to provide long-term capital appreciation. The International Equity Fund invests in equity securities of non-U.S. issuers. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. The Emerging Markets Growth Fund and the International Equity Fund are sub-advised by Marvin & Palmer Associates, Inc. ("Marvin & Palmer") and Boston International Advisors, Inc. ("Boston International"), respectively. PURCHASING AND REDEEMING SHARES For information on purchasing Class A, Class B, and Class C Shares of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The foreign securities in which the Funds may invest may be subject to certain risks in addition to those inherent in U.S. investments. The Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, investing in when-issued securities, lending portfolio securities and entering into futures contracts and related options as hedges. These risks are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS A SHARES
Emerging Markets International Growth Fund Equity Fund ---------------- ------------- Class A Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)............ 4.75% 4.75% Maximum Sales Load Imposed on Reinvested Divi- dends (as a percentage of offering price)............ None None Contingent Deferred Sales Charge (as a percent- age of original purchase price or redemption proceeds, as applicable)............ None None Redemption Fees (as a percentage of amount re- deemed, if applicable)......................... None None Exchange Fee.................................... None None Annual Class A Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (1)............... 0.00% 0.21% 12b-1 Fees (2).................................. 0.25% 0.25% Total Other Expenses (after waiver) (3)......... 1.50% 0.79% Total Class A Shares Operating Expenses (4)... 1.75% 1.25%
(1) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the anticipated voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (2) The Class A Shares can pay up to 0.75 of 1% of Class A Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit the Class A Shares' 12b-1 payments to 0.25 of 1% of Class A Shares' average daily net assets. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.73% and 0.96%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class A Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 1.78% and 1.26%, respectively, for the fiscal year ended December 31, 1994. Total Class A Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 3.96% and 2.09%, respectively, for the fiscal year ended December 31, 1994. The Annual Class A Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class A Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 4.48% and 2.03%, respectively, absent the voluntary waivers and reimbursements described above in notes 1 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return; (2) redemption at the end of each time period; and (3) payment of maximum sales load. The Funds charge no redemption fees for Class A Shares. Emerging Markets Growth Fund................................. $64 $100 International Equity Fund.................................... $60 $ 85
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. This example is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class A Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. Y Shares, Class B Shares and Class C Shares do not bear a front-end sales load. See "Other Classes of Shares." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS B SHARES
Emerging Markets Growth Fund International Equity Fund ----------------------------- ----------------------------- Class B Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a percentage of original 5% during the first year, 5% during the first year, purchase price or 4% during the second year, 4% during the second year, redemption proceeds, as 3% during the third year, 3% during the third year, applicable) (1)........ 3% during the fourth year, 3% during the fourth year, 2% during the fifth year, 2% during the fifth year, 1% during the sixth year, 1% during the sixth year, 1% during the seventh year, 1% during the seventh year, and 0% after the seventh year and 0% after the seventh year Redemption Fees (as a percentage of amount redeemed, if applica- ble)................... None None Exchange Fee............ None None Annual Class B Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)............ 0.00% 0.21% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver) (3)..... 1.75% 1.04% Shareholder Services Fee................. 0.25% 0.25% Total Class B Shares Op- erating Expenses (4)................. 2.50% 2.00%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than seven years prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per Share. (2) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the anticipated voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.98% and 1.21%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class B Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 2.53% and 2.02%, respectively, for the fiscal year ended December 31, 1994. Total Class B Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 4.71% and 2.85%, respectively, for the fiscal year ended December 31, 1994. The Annual Class B Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class B Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 5.23% and 2.78%, respectively, absent the voluntary waivers and reimbursements described above in notes 2 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period: Emerging Markets Growth Fund....................................................... $77 $110 International Equity Fund.......................................................... $72 $96 You would pay the following expenses on the same investment, assuming no redemptions: Emerging Markets Growth Fund....................................................... $25 $78 International Equity Fund.......................................................... $20 $63
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The example for Class B Shares is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class B Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class A Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1%and bear a maximum sales load of 4.75%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS C SHARES
Emerging Markets Growth Fund International Equity Fund --------------------------- --------------------------- Class C Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a per- centage of original purchase price or redemption proceeds, as applica- 1% during the first year, 1% during the first year, ble) (1)............... and 0% after the first year and 0% after the first year Redemption Fees (as a percentage of amount redeemed, if applica- ble)................... None None Exchange Fee............ None None Annual Class C Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)............ 0.00% 0.21% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver) (3)..... 1.75% 1.04% Shareholder Services Fee.................... 0.25% 0.25% Total Class C Shares Operating Expenses (4). 2.50% 2.00%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than one year prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per Share. (2) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.98% and 1.21%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class C Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 2.53% and 2.01%, respectively, for the fiscal year ended December 31, 1994. Total Class C Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 4.71% and 2.84%, respectively, for the fiscal year ended December 31, 1994. The Annual Class C Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class C Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 5.23% and 2.78%, respectively, absent the voluntary waivers and reimbursements described above in notes 2 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period: Emerging Markets Growth Fund................................. $36 $78 International Equity Fund.................................... $31 $63 You would pay the following expenses on the same investment, assuming no redemptions: Emerging Markets Growth Fund................................. $25 $78 International Equity Fund.................................... $20 $63
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. This example for Class C Shares is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class C Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class A Shares, and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales load of 4.75%. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales load. See "Other Classes of Shares." FINANCIAL HIGHLIGHTS First Union Emerging Markets Growth Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Y Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.00 (0.02) (0.02) 0.01 - ------------------------ Net realized and unrealized gain (loss) on investments and translation of assets and liabilities in for- eign currency (1.83) (1.82) (1.82) (1.84) - ------------------------ ------ ------ ------ ------ Total from investment operations (1.83) (1.84) (1.84) (1.83) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.00) (0.00) (0.00) (0.00) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 8.17 $ 8.16 $ 8.16 $ 8.17 - ------------------------ ------ ------ ------ ------ Total return+ (18.30%) (18.40%) (18.40%) (18.30%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.78%(b) 2.53%(b) 2.53%(b) 1.53%(b) - ------------------------ Net investment income (0.12%)(b) (0.84%)(b) (0.82%)(b) 0.43%(b) - ------------------------ Expense waiver/reimbursement (a) 2.18%(b) 2.18%(b) 2.18%(b) 2.18%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $867 $1,589 $89 $5,878 - ------------------------ Portfolio turnover rate 17% 17% 17% 17% - ------------------------
* Reflects operations for the period from September 6, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS First Union International Equity Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Y Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.02 0.00 0.03 0.02 - ------------------------ Net realized and unrealized gain (loss) on investments (0.52) (0.50) (0.54) (0.51) - ------------------------ ------ ------ ------ ------ Total from investment operations (0.50) (0.50) (0.51) (0.49) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.00) (0.00) (0.00) (0.01) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.50 $ 9.50 $ 9.49 $ 9.50 - ------------------------ ------ ------ ------ ------ Total return+ (5.08%) (5.19%) (5.19%) (5.02%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.26%(b) 2.02%(b) 2.01%(b) 1.06%(b) - ------------------------ Net investment income 0.91%(b) 0.10%(b) 0.85%(b) 1.03%(b) - ------------------------ Expense waiver/reimbursement (a) 0.83%(b) 0.83%(b) 0.83%(b) 0.83%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $2,545 $5,602 $163 $23,830 - ------------------------ Portfolio turnover rate 1% 1% 1% 1% - ------------------------
* Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES AND POLICIES First Union Growth Funds offer investors the opportunity to invest in international equity securities of developed and emerging market issuers. The investment objectives and policies of both Funds are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION EMERGING MARKETS GROWTH PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of emerging market issuers. Suitable for: Aggressive investors interested in the investment opportunities offered by securities in emerging markets. Key Benefit: Provides potential for growth opportunities by investing in emerging markets experiencing political change, economic deregulation and liberalized trade policies. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in a diversified portfolio of equity securities of issuers located in countries with emerging markets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in securities of emerging market issuers. A country will be considered to have an "emerging market" if it has relatively low gross national product per capita compared to the world's major economies and the potential for rapid economic growth. Countries with emerging markets include those that have an emerging stock market (as defined by the International Finance Corporation), those with low- to middle-income economies (according to the World Bank), and those listed in World Bank publications as "developing." The Fund will normally invest in at least six different countries, although it may invest all of its assets in a single country. At the present time, the Fund has no intention to invest all of its assets in a single country. The Fund focuses on equity securities, but may also invest in other types of instruments, including debt securities. Marvin & Palmer, the Sub- Adviser to the Fund, will make investment decisions regarding equity securities based on its analysis of returns, price momentum, business and industry considerations, and management quality. FIRST UNION INTERNATIONAL EQUITY PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of non-U.S. issuers. Suitable for: Investors who want to pursue their investment goals in markets outside the United States. Key Benefit: Provides potential for investment opportunities in countries outside the U.S. due to differing economic and political cycles. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in foreign equity securities that Boston International, the Sub-Adviser to the Fund, determines, through both fundamental and technical analysis, to be undervalued compared to other securities in their industries and countries. In most market conditions, the stocks comprising the Fund's assets will exhibit traditional value characteristics, such as higher than average dividend yields, lower than average price to book value, and will include stocks of companies with unrecognized or undervalued assets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in equity securities of issuers located in at least three countries outside of the United States. The Fund will emphasize value stocks, primarily of companies which are listed on one or more of thirty-two stock markets: twenty developed markets and twelve emerging markets. While the current intention of the Fund is to invest in 32 stock markets, the Fund may invest in more or less, depending upon market conditions as determined by the Sub-Adviser. The Fund will invest substantially in industrialized companies throughout the world that comprise the Morgan Stanley Capital International EAFE (Europe, Australia and the Far East) Index. In addition, the Fund intends to invest up to 10% of its assets in emerging country equity securities, as described above under "First Union Emerging Markets Growth Portfolio--Description of the Fund." TYPES OF INVESTMENTS The Funds primarily invest in: common and preferred stocks, convertible securities and warrants of foreign corporations. Common stocks represent an equity interest in a corporation. This ownership interest often gives the Funds the right to vote on measures affecting the company's organization and operations. Although common stocks have a history of long-term growth in value, their prices tend to fluctuate in the short-term, particularly those of smaller capitalization companies. Smaller capitalization companies may have limited product lines, markets, or financial resources. These conditions may make them more susceptible to setbacks and reversals. Therefore, their securities may have limited marketability and may be subject to more abrupt or erratic market movements than securities of larger companies; obligations of foreign governments and supranational organizations; corporate and foreign government fixed income securities denominated in currencies other than U.S. dollars, rated, at the time of purchase, Baa or higher by Moody's Investors Service, Inc. ("Moody's") or BBB or higher by Standard & Poor's Ratings Group ("S&P"), or which, if unrated, are considered to be of comparable quality by the Sub-Advisers. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. Although the Funds do not intend to invest significantly in debt securities, it should be noted that the prices of fixed income securities fluctuate inversely to the direction of interest rates; strategic investments, such as options and futures contracts on currency transactions, securities index futures contracts, and forward foreign currency exchange contracts. The Funds can use these techniques to increase or decrease their exposure to changing security prices, interest rates, currency exchange rates, or other factors that affect security values. (Although, of course, there can be no assurance that these strategic investments will be successful in protecting the value of the Funds' securities.); securities of closed-end investment companies; and repurchase agreements collateralized by eligible investments. OTHER INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Funds' risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Funds to sell the security in the open market in the case of a default. In such a case, the Funds may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Funds purchase securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause the Funds to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, the Funds may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. FOREIGN CURRENCY TRANSACTIONS The Funds will enter into foreign currency transactions to obtain the necessary currencies to settle securities transactions. Currency transactions may be conducted either on a spot or cash basis at prevailing rates or through forward foreign currency exchange contracts. The Funds may also enter into foreign currency transactions to protect Fund assets against adverse changes in foreign currency exchange rates or exchange control regulations. Such changes could unfavorably affect the value of Fund assets which are denominated in foreign currencies, such as foreign securities or funds deposited in foreign banks, as measured in U.S. dollars. Although foreign currency exchanges may be used by a Fund to protect against a decline in the value of one or more currencies, such efforts may also limit any potential gain that might result from a relative increase in the value of such currencies and might, in certain cases, result in losses to the Fund. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS A forward foreign currency exchange contract ("forward contract") is an obligation to purchase or sell an amount of a particular currency at a specific price and on a future date agreed upon by the parties. Generally, no commission charges or deposits are involved. At the time a Fund enters into a forward contract, Fund assets with a value equal to the Fund's obligation under the forward contract are segregated and are maintained until the contract has been settled. The Funds will not enter into a forward contract with a term of more than one year. The Funds will generally enter into a forward contract to provide the proper currency to settle a securities transaction at the time the transaction occurs ("trade date"). The period between trade date and settlement date will vary between 24 hours and 60 days, depending upon local custom. The Funds may also protect against the decline of a particular foreign currency by entering into a forward contract to sell an amount of that currency approximating the value of all or a portion of the Funds' assets denominated in that currency ("hedging"). The success of this type of short-term hedging strategy is highly uncertain due to the difficulties of predicting short-term currency market movements and of precisely matching forward contract amounts and the constantly changing value of the securities involved. Although the Sub- Advisers will consider the likelihood of changes in currency values when making investment decisions, each Sub-Adviser believes that it is important to be able to enter into forward contracts when it believes the interests of a Fund will be served. The Funds will not enter into forward contracts for hedging purposes in a particular currency in an amount in excess of the Funds' assets denominated in that currency, but as consistent with their other investment policies and as not otherwise limited in their ability to use this strategy. OPTIONS AND FUTURES The Funds may deal in options on foreign currencies, securities indices and portfolio securities, which options may be listed for trading on an international securities exchange. The Funds will use these options to manage interest rate and currency risks. The Funds also may write covered call options and secured put options to generate income or to lock in gains. Each Fund may write covered call options and secured put options on up to 25% of its net assets and may purchase put and call options provided that no more than 5% of the fair market value of its net assets may be invested in premiums on such options. A call option gives the purchaser the right to buy, and the writer the obligation to sell, the underlying asset at the exercise price during the option period. A put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying asset at the exercise price during the option period. The writer of a covered call owns assets that are acceptable for escrow and the writer of a secured put invests an amount not less than the exercise price in eligible assets to the extent that it is obligated as a writer. If a call written by a Fund is exercised, the Fund forgoes any possible profit from an increase in the market price of the underlying asset over the exercise price plus the premium received. In writing puts, there is a risk that a Fund may be required to take delivery of the underlying asset at a disadvantageous price. The Funds may enter into futures contracts involving foreign currency and securities indices, or options on currency, for bona fide hedging purposes. The Funds may also enter into such futures contracts or related options for purposes other than bona fide hedging if the aggregate amount of initial margin deposits on a Fund's futures and related options positions would not exceed 5% of the net liquidation value of the Fund's assets, provided further that in the case of an option that is in-the-money at the time of the purchase, the in-the-money amount may be excluded in calculating the 5% limitation. In addition, a Fund may not sell futures contracts if the value of such futures contracts exceeds the total market value of the Fund's portfolio securities. Futures contracts sold by a Fund are generally subject to segregation and coverage requirements established by either the Commodity Futures Trading Commission ("CFTC") or the Securities and Exchange Commission ("SEC"), with the result that, if a Fund does not hold the instrument underlying the futures contract or option, the Fund will be required to segregate, on an ongoing basis with its custodian, cash, U.S. government securities, or other liquid high grade debt obligations in an amount at least equal to the Fund's obligations with respect to such instruments. The Funds may enter into securities index futures contracts and purchase and write put and call options on securities index futures contracts that are traded on regulated exchanges, including non-U.S. exchanges, to the extent permitted by the CFTC. Securities index futures contracts are based on indices that reflect the market value of securities of the firms included in the indices. An index futures contract is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to the differences between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally written. The Funds may enter into securities index futures contracts to sell a securities index in anticipation of or during a market decline to attempt to offset the decrease in market value of securities in its portfolio that might otherwise result. When a Fund is not fully invested and anticipates a significant market advance, it may enter into futures contracts to purchase the index in order to gain rapid market exposure that may in part or entirely offset increases in the cost of securities that it intends to purchase. In many of these transactions, a Fund will purchase such securities upon termination of the futures position but, depending on market conditions, a futures position may be terminated without the corresponding purchases of common stock. A Fund may also invest in securities index futures contracts when its Sub-Adviser believes such investment is more efficient, liquid or cost-effective than investing directly in the securities underlying the index. The use of futures and related options involves special considerations and risks, including: (1) the ability of a Fund to utilize futures successfully will depend on its Sub-Adviser's ability to predict pertinent market movements; and (2) there might be an imperfect correlation (or conceivably no correlation) between the change in the market value of the securities held by a Fund and the prices of the futures relating to the securities purchased or sold by the Fund. The use of futures and related options may reduce risk of loss by wholly or partially offsetting the negative effect of unfavorable price movements, but these instruments can also reduce the opportunity for gain by offsetting the positive effect of favorable price movements in positions. No assurance can be given that a Sub-Adviser's judgment in this respect will be correct. It is not certain that a secondary market for positions in futures contracts or for options will exist at all times. Although each Sub-Adviser will consider liquidity before entering into these transactions, there is no assurance that a liquid secondary market on an exchange or otherwise will exist for any particular futures contract or option at any particular time. A Fund's ability to establish and close out futures and options positions depends on this secondary market. RISK CHARACTERISTICS OF FOREIGN SECURITIES Investing in non-U.S. securities carries substantial risks in addition to those associated with domestic investments. In an attempt to reduce some of these risks, the Funds diversify their investments broadly among foreign countries which may include both developed and developing countries. With respect to the International Equity Fund, at least three different countries will always be represented. The Funds may take advantage of the unusual opportunities for higher returns available from investing in developing countries. As discussed in detail below under "Emerging Markets," however, these investments carry considerably more volatility and risk because they generally are associated with less mature economies and less stable political systems. Foreign securities are denominated in foreign currencies. Therefore, the value in U.S. dollars of a Fund's assets and income may be affected by changes in exchange rates and regulations. Although the Funds value their assets daily in U.S. dollars, they will not convert their holdings of foreign currencies to U.S. dollars daily. When a Fund converts its holdings to another currency, it may incur conversion costs. Foreign exchange dealers realize a profit on the difference between the prices at which such dealers buy and sell currencies. To the extent that securities purchased by the Funds are denominated in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the Funds' net asset values; the value of interest earned; gains and losses realized on the sale of securities; and net investment income and capital gains, if any, to be distributed to shareholders by a Fund. If the value of a foreign currency rises against the U.S. dollar, the value of a Fund's assets denominated in that currency will increase; correspondingly, if the value of a foreign currency declines against the U.S. dollar, the value of a Fund's assets denominated in that currency will decrease. Other differences between investing in foreign and U.S. companies include: less publicly available information about foreign companies; the lack of uniform financial accounting standards applicable to foreign companies; less readily available market quotations on foreign companies; differences in government regulation and supervision of foreign stock exchanges, brokers, listed companies, and banks; differences in legal systems which may affect the ability to enforce contractual obligations or obtain court judgments; generally lower foreign stock market volume; the likelihood that foreign securities may be less liquid or more volatile; foreign brokerage commissions may be higher; unreliable mail service between countries; and political or financial changes which adversely affect investments in some countries. In the past, U.S. government policies have discouraged or restricted certain investments abroad by investors such as the Funds. Although the Funds are unaware of any current restrictions, investors are advised that these policies could be reinstituted. EMERGING MARKETS The economies of individual emerging countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, currency depreciation, capital reinvestment, resource self-sufficiency and balance of payments position. Further, the economies of developing countries generally are heavily dependent on international trade and, accordingly, have been, and may continue to be, adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, adversely affected by economic conditions in the countries with which they trade. Prior governmental approval for foreign investments may be required under certain circumstances in some emerging countries, and the extent of foreign investment in certain debt securities and domestic companies may be subject to limitation in other emerging countries. Foreign ownership limitations also may be imposed by the charters of individual companies in emerging countries to prevent, among other concerns, violation of foreign investment limitations. Repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some emerging countries. A Fund could be adversely affected by delays in, or a refusal to grant, any required governmental registration or approval for such repatriation. Any investment subject to such repatriation controls will be considered illiquid if it appears reasonably likely that this process will take more than seven days. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, governmental regulation, social instability or diplomatic developments (including war) which could affect adversely the economics of such countries or the value of the Funds' investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside ofthe U.S. TEMPORARY INVESTMENTS The Funds may invest in U.S. and foreign short-term money market instruments (denominated in U.S. and/or foreign currencies), including interest-bearing call deposits with banks, government obligations, certificates of deposit, bankers' acceptances, commercial paper, short-term corporate debt securities, and repurchase agreements. These investments may be used to temporarily invest cash received from the sale of Fund shares, to establish and maintain reserves for temporary defensive purposes, or to take advantage of market opportunities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Funds may invest up to 10% of their total assets in the securities of closed-end investment companies, including regional or single-country funds. To the extent that the Funds invest in securities issued by other investment companies, the Funds will indirectly bear their proportionate share of any fees and expenses paid by such companies, in addition to the fees and expenses payable directly by the Funds. RESTRICTED AND ILLIQUID SECURITIES The Funds may not invest more than 5% of their total assets in securities which are subject to restrictions on resale under federal securities law, except for restricted securities which meet the criteria for liquidity as established by the Trustees. The Funds may invest up to 15% of their net assets in illiquid securities. Illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one third of the value of its total assets and pledge up to 15% of the value of those assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of its total assets, neither Fund may invest more than 5% of its total assets in the securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. Each Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. There is the risk that when lending portfolio securities, the securities may not be available to the Funds on a timely basis and the Funds may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. DOWNGRADES If any security purchased by either of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. SHAREHOLDER GUIDE CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing Class A Shares, Class B Shares or Class C Shares. Your decision will be based on the amount of your intended purchase and how long you expect to hold the Shares. Each Fund offers three types of Investment Shares: Class A Shares, Class B Shares and Class C Shares. Each Share of the Fund represents an identical interest in the investment portfolio of the Fund and has the same rights. The difference between Class A Shares, Class B Shares, and Class C Shares is based on purchasing arrangements and distribution and shareholder services expenses. Class A Shares have a sales charge included at the time of purchase and are subject to a Rule 12b-1 distribution fee of 0.25 of 1%. This means that investors can purchase fewer Class A Shares for the same initial investment than Class B Shares or Class C Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class B Shares impose a maximum contingent deferred sales charge ("CDSC") of 5.00%. In addition, Class B Shares impose a CDSC on most redemptions made within seven years of purchase, have distribution costs resulting from Rule 12b-1 distribution fees of 0.75 of 1% and a shareholder services fee of 0.25 of 1%. In addition, at the end of the seven year period, Class B Shares may automatically convert to Class A Shares and thus be subject to lower Rule 12b-1 distribution fees. Class C Shares impose a CDSC of 1.00 of 1% on most redemptions made within the first 12 months of purchase, have a Rule 12b-1 distribution fee of 0.75 of 1%, and a shareholder services fee of 0.25 of 1% This means that investors may purchase more Class B Shares or Class C Shares than Class A Shares for the same initial investment, but will receive lower dividends per Share. Investors should consider whether, during the anticipated life of their investment in the Fund, the accumulated Rule 12b-1 fee, CDSC, and shareholder services fee on either Class B Shares or Class C Shares would be less than the initial sales charge and accumulated Rule 12b-1 fee on Class A Shares purchased at the same time. Investors must also consider how each differential would be offset by the higher yield of Class A Shares. SHARE PRICE CALCULATION The net asset value of a Fund Share equals the market value of all the Fund's portfolio securities divided by the total Shares outstanding. It is also the bid price. The offering price is quoted after adding a sales charge to the net asset value. Purchases, redemptions, and exchanges are all based on net asset value. (The purchase price of Class A Shares adds an applicable sales charge, and the redemption proceeds of Class B Shares and Class C Shares deduct an applicable CDSC.) The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares, and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Class A Shares, Class B Shares, and Class C Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yields of Class A Shares, Class B Shares and Class C Shares are calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Class A Shares, Class B Shares and Class C Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Performance information for the Class A Shares, Class B Shares and Class C Shares reflects the effect of a sales charge which, if excluded, would increase the total return and yield. Total return and yield will be calculated separately for Class A Shares, Class B Shares, Class C Shares and Y Shares of a Fund. Because Class A Shares are subject to 12b-1 fees, and Class B Shares and Class C Shares are subject to a 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (in the case of Class A Shares), or (ii) on a contingent deferred basis (in the case of Class B Shares or Class C Shares). MINIMUM INVESTMENT You may invest as often as you want in the Funds. There is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Mutual Funds Group of First Union Brokerage Services ("FUBS"), a subsidiary of First Union, at 1-800-326-3241. Subsequent investments may be in any amounts. WHAT SHARES COST Class A Shares are sold at their net asset value plus a sales charge as follows:
Sales Charge as Sales Charge as a a Percentage of Percentage of Net Amount of Transaction Public Offering Price Amount Invested --------------------- --------------------- ----------------- $ 0-$ 99,999 4.75% 4.99% $ 100,000-$ 249,999 3.75% 3.90% $ 250,000-$ 499,999 3.00% 3.10% $ 500,000-$ 999,999 2.00% 2.04% $1,000,000-$2,499,999 1.00% 1.01% $2,500,000+ 0.25% 0.25%
Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. (the "distributor" or "FSC") and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. Sales charges may be reduced in some cases. You may be entitled to a reduction if: (1) you make a single large purchase, (2) you, your spouse and/or children (under 21 years) make Fund purchases on the same day, (3) you make an additional purchase to add to an existing account, (4) you sign a letter of intent indicating your intention to purchase at least $100,000 of Shares over the next 13 months, (5) you reinvest in a Fund within 30 days of redemption, or (6) you combine purchases of two or more First Union Funds which include front- end sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non- qualified employee benefit and savings plans which make Shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount up to .50 of 1% of the net asset value of the Class A Shares purchased. These payments are subject to reclaim in the event the Class A Shares are redeemed within 12 months after purchase. In all of these cases, you must notify the distributor of your intentions in writing in order to qualify for a sales charge reduction. For more information, consult the Funds' Statement of Additional Information or the distributor. Class B Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within seven years of their purchase will be subject to a CDSC according to the following schedule:
Year of Redemption Contingent Deferred After Purchase Sales Charge ------------------ ------------------- First 5.0% Second 4.0% Third 3.0% Fourth 3.0% Fifth 2.0% Sixth 1.0% Seventh 1.0%
Class C Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within one year of their purchase will be subject to a CDSC of 1.00%. With respect to Class B Shares and Class C Shares, no CDSC will be imposed on: (1) the portion of redemption proceeds attributable to increases in the value of the account due to increases in the net asset value per Share, (2) Shares acquired through reinvestment of dividends and capital gains, (3) Shares held for more than seven years (in the case of Class B Shares) or one year (in the case of Class C Shares) after the end of the calendar month of acquisition, (4) accounts following the death or disability of a shareholder, or (5) minimum required distributions to a shareholder over the age of 70 1/2 from an IRA or other retirement plan. CONVERSION FEATURE Class B Shares include all Shares purchased pursuant to the deferred sales charge alternative which have been outstanding for less than the period ending seven years after the end of the month in which the shareholder's order to purchase Class B Shares was accepted. At the end of this seven year period, Class B Shares may automatically convert to Class A Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class B Shares. Such conversion will be on the basis of the relative net asset values of the two classes, without the imposition of any sales load, fee or other charge. The purpose of the conversion feature is to relieve the holders of the Class B Shares that have been outstanding for a period of time sufficient for the distributor to have been compensated for distribution expenses related to the Class B Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class A Shares, Class B Shares purchased through the reinvestment of dividends and distributions paid on Class B Shares in a shareholder's Fund acount will be considered to be held in a separate sub- account. Each time any Class B Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class A Shares, an equal pro rata portion of the Class B Shares in the sub-account will also convert to Class A Shares. The availability of the conversion feature is subject to the granting of an exemptive order (the "Order") by the SEC or the adoption of a rule permitting such conversion. In the event that the Order or rule ultimately issued by the SEC requires any conditions additional to those described in this prospectus, shareholders will be notified. BY TELEPHONE OR IN PERSON You may purchase Class A Shares, Class B Shares and Class C Shares by telephone from the Mutual Funds Group of FUBS at 1-800-326-3241 or you may place the order in person at any First Union branch location. Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. All purchase orders received prior to 4:00 p.m. (Eastern time) on a regular business day are processed at that day's offering price. Payment is required within five business days. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. DEALER CONCESSION For sales of Shares of the Funds, a dealer will normally receive up to 85% of the applicable sales charge. Any portion of the sales charge which is not paid to a dealer will be retained by the distributor. However, the distributor, in its sole discretion, may uniformly offer to pay to all dealers selling Shares of the Funds, all or a portion of the sales charge it normally retains. If accepted by the dealer, such additional payments will be predicated upon the amount of Fund Shares sold. The sales charge for Shares sold other than through registered broker/dealers will be retained by FSC. FSC may pay fees to banks out of the sales charge in exchange for sales and/or administrative services performed on behalf of the bank's customers in connection with the initiation of customer accounts and purchases of Shares. From time to time, the distributor will conduct sales programs or contests that compensate brokers with cash or non-cash items, such as merchandise and attendance at sales seminars in resort locations. The cost of such compensation is borne by the distributor and is not a Fund expense. HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call FUBS at 1-800-326-3241 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another, which may produce a gain or loss for tax purposes. You may exchange Class A Shares of one First Union Fund for Class A Shares of any other First Union Fund, Class B Shares of one First Union Fund for Class B Shares of any other First Union Fund, or Class C Shares of one First Union Fund for Class C Shares of any other First Union Fund by calling toll free 1-800- 326-3241 or by writing to FUBS. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and, shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. The exchange of Class B Shares or Class C Shares will not be subject to a CDSC. However, if the shareholder redeems Class B Shares within seven years of the original purchase or Class C Shares within one year of the original purchase, a CDSC will be imposed. For purposes of computing the CDSC, the length of time the shareholder has owned Class B Shares or Class C Shares will be measured from the date of original purchase and will not be affected by the exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less, in the case of Class B Shares or Class C Shares, any applicable CDSC. You may redeem Shares in three ways: (1) by telephoning FUBS at 1-800-326- 3241, (2) by written request to FUBS or Federated Services Company, c/o State Street Bank and Trust Company, P.O. Box 8609, Boston, Massachusetts 02266- 8609, or (3) in person at First Union. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record, normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. ADDITIONAL SHAREHOLDER SERVICES TELEPHONE SERVICES You may authorize electronic transfers of money to purchase Shares in any amount or to redeem any or all Shares in an account. The service may be used like an "electronic check" to move money between a bank account and an account in a Fund with a single telephone call. SYSTEMATIC INVESTMENT PLAN You may arrange for systematic monthly or quarterly investments in your account in amounts of $25 or more by directly debiting your bank account. TAX SHELTERED PLANS You may open a pension and profit sharing account in any First Union Fund (except those First Union Funds having an objective of providing tax free income), including Individual Retirement Accounts ("IRAs"), Rollover IRAs, Keogh Plans, Corporate Profit-Sharing, Pension and Salary-Reduction Plans. For details, including fees and application forms, call First Union toll free at 1- 800-669-2136 or write to First Union National Bank of North Carolina, Retirement Services, 301 South College Street, Charlotte, NC 28288-1169. SYSTEMATIC CASH WITHDRAWAL PLAN When an account of $10,000 or more is opened or when an existing account reaches that size, you may participate in a Fund's Systematic Cash Withdrawal Plan by filling out the appropriate part of the share purchase application. Under this Plan, you may receive (or designate a third party to receive) a monthly or quarterly check in a stated amount of not less than $25. Fund Shares will be redeemed as necessary to meet withdrawal payments. All participants must elect to have their dividends and capital gain distributions reinvested automatically. Any applicable Class B CDSC will be waived with respect to redemptions occurring under a Systematic Cash Withdrawal Plan during a calendar year to the extent that such redemptions do not exceed 10% of (i) the initial value of the account, plus (ii) the value, at the time of purchase, of any subsequent investments. MANAGEMENT OF FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Sub-Advisers, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. William R. Hackney, III, is Senior Vice President and Chief Investment Officer of the Capital Management Group of First Union National Bank of North Carolina, N.A. Prior to assuming his current position with First Union, Mr. Hackney served as Regional Research Director for E.F. Hutton & Company's Southeast Region. Mr. Hackney has managed the Funds since their inception in September 1994. SUB-ADVISERS Under the terms of the Sub-Advisory Agreements between First Union National Bank and the respective Sub-Advisers, the Sub-Advisers will be responsible for managing that portion or all of each Fund's portfolio as designated by the Adviser, selecting investments for purchase or sale, along with the countries in which each Fund will invest and the dealers in portfolio securities, in accordance with each Fund's investment objectives, policies and limitations as stated herein. EMERGING MARKETS GROWTH FUND Marvin & Palmer Associates, Inc. is Sub-Adviser for the Emerging Markets Growth Fund. Marvin & Palmer, a privately-held company, was founded in 1986 by David F. Marvin and Stanley Palmer. The stock of Marvin & Palmer is owned by Mr. Marvin, Mr. Palmer and seventeen other shareholders. Marvin & Palmer is engaged in the management of global, non-United States and emerging markets equity portfolios for institutional accounts. At June 30, 1994, Marvin & Palmer managed a total of $2.5 billion in investments for 34 institutional investors and 5 commingled funds and served as sub-adviser to another investment company with total assets of $33 million. David F. Marvin is Chairman of the Sub-Adviser and founded the firm, together with Mr. Palmer, in 1986. With respect to the Emerging Markets Growth Fund, Mr. Marvin is primarily responsible for Latin America and currency management, and has served as co-portfolio manager of the Fund since its inception in September 1994. Stanley Palmer is President of the Sub-Adviser and a co-founder of the firm. With respect to the Emerging Markets Growth Fund, Mr. Palmer is, along with Todd D. Marvin, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. Terry B. Mason is a Vice President of and Portfolio Manager for the Sub- Adviser. Before joining the Sub-Adviser in 1990, Mr. Mason was employed for 14 years by DuPont Corporation, the last five as an International Equity Analyst and an International Trader. With respect to the Emerging Markets Growth Fund, Mr. Mason is primarily responsible for Eastern Europe and Africa, and has served as co-portfolio manager of the Fund since its inception in September 1994. Jay F. Middleton is a portfolio manager for the Sub-Adviser and joined the firm in 1989. With respect to the Emerging Markets Growth Fund, Mr. Middleton is primarily responsible for Latin America and the Middle East, and has served as co-portfolio manager of the Fund since its inception in September 1994. Todd D. Marvin is a Portfolio Manager for the Sub-Adviser and joined the firm in 1991. Before joining the Sub-Adviser, Mr. Marvin was employed by Oppenheimer & Company as an analyst in its investment banking department from 1989 until 1991. With respect to the Emerging Markets Growth Fund, Mr. Marvin is, along with Mr. Palmer, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. INTERNATIONAL EQUITY FUND Boston International Advisors, Inc. is Sub-Adviser for the International Equity Fund. Boston International commenced operations in 1986 and specializes in the management of international equity portfolios. Boston International manages eighteen international portfolios, including five group trust funds throughout the world. Messrs. Lyle H. Davis, Norman H. Meltz and David A. Umstead, the principal executive officers of Boston International, each owns more than 25% of the outstanding voting securities of Boston International. As of June 30, 1994, Boston International managed a total of $2.7 billion in assets and served as sub-adviser to one other investment company with total assets of $148 million. Maureen Ghublikian has been a Managing Director of the Sub-Adviser since the firm's inception in 1986. Ms. Ghublikian has served as co-portfolio manager of the Fund since its inception in September 1994. David A. Umstead was a founder and has been a Managing Director of the Sub- Adviser since the firm's inception in 1986. Mr. Umstead has served as co- portfolio manager of the Fund since its inception in September 1994. DISTRIBUTION OF INVESTMENT SHARES FSC, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Each class of Investment Shares of a Fund has adopted a separate plan for distribution of Shares permitted by Rule 12b-1 under the Investment Company Act of 1940 (the "Plans"), whereby each Fund has authorized a daily expense ("Rule 12b-1 fee") at an annual rate of up to 0.75 of 1% of the average daily net asset value of that Fund's respective class to finance the sale of Shares. It is currently intended that annual Rule 12b-1 fees will be limited for the foreseeable future to payments to the distributor equal to 0.25 of 1% for Class A Shares of the Emerging Markets Growth and International Equity Funds and 0.75% for Class B Shares and Class C Shares of each Fund's respective average daily net asset value. The distributor may pay all or a portion of the Rule 12b-1 fee to compensate selected brokers and financial institutions for selling Shares or for administrative services rendered in connection with the Shares. The Funds make no payments in connection with the sale of Shares other than the Rule 12b-1 fees paid to its distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. Except as set forth in the next paragraph, the Funds do not pay for unreimbursed expenses of the distributor. Since the Funds' Plans are "compensation" type plans, however, future Rule 12b-1 fees may permit recovery of such amounts or may result in a profit to the distributor. The distributor may sell, assign or pledge its right to receive Rule 12b-1 fees and CDSCs to finance payments made to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class B Shares and Class C Shares at any given time may exceed the Rule 12b-1 fees and payments received pursuant to CDSCs. These unrecovered amounts, plus interest thereon, will be carried forward and paid from future Rule 12b-1 fees and payments received through CDSCs. If a Plan were terminated or not continued, the Funds would not be contractually obligated to pay for any expenses not previously reimbursed by the Funds or recovered through CDSCs. FSC, from time to time, may pay brokers additional sums of cash or promotional incentives based upon the amount of Shares sold. Such payments, if made, will be in addition to amounts paid under the Plans and will not be an expense of the Funds. FUND ADMINISTRATION Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The Funds may pay a shareholder servicing agent (the "Shareholder Servicing Agent") a fee based on average daily net asset value for Class B Shares and Class C Shares of the Funds for which the Shareholder Servicing Agent provides shareholder services. As such, the Shareholder Servicing Agent provides shareholder services which include, but are not limited to: distributing prospectuses and other information, providing shareholder assistance, and communicating or facilitating purchases and redemptions of Class B Shares and Class C Shares. The Funds may pay the Shareholder Servicing Agent a fee equal to 0.25 of 1% of the average daily net asset value of Class B Shares and Class C Shares for which the Shareholder Servicing Agent provides shareholder services. The Shareholder Servicing Agent may voluntarily choose to waive all or a portion of its fee at any time. First Union Brokerage Services, First Union National Bank of North Carolina, and other financial institutions may serve as Shareholder Servicing Agent. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY, SUB-ADVISORY, AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Adviser receives an annual investment advisory fee with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- 1.50% on the first $100 million 1.45% on the next $100 million 1.40% on the next $100 million 1.35% on assets in excess of $300 million
International Equity Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- .82% on the first $20 million .79% on the next $30 million .76% on the next $50 million .73% on assets in excess of $100 million
The fees paid by the Emerging Markets Growth Fund and the International Equity Fund are higher than the advisory fees paid by other mutual funds in general; however, the fees paid by the International Equity Fund are comparable to fees paid by many mutual funds with similar investment objectives and policies. For its services under its Sub-Advisory Contract with the Adviser, each Sub- Adviser receives a monthly fee calculated on an annual basis, payable by the Adviser, for its services and expenses incurred with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund--Marvin & Palmer
Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- 1.00% on the first $100 million .95% on the next $100 million .90% on the next $100 million .85% on assets in excess of $300 million
International Equity Fund--Boston International
Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- .32% on the first $20 million .29% on the next $30 million .26% on the next $50 million .23% on assets in excess of $100 million
The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below:
Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust ------------------- --------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million
Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND INVESTMENT SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering the Fund and Shares of the Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 1,471,138 shares (53.26%) and 1,290,972 shares (46.74%), respectively, of International Equity Fund-Y Shares; and First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 655,750 shares (84.77%) of the Emerging Markets Growth Fund-Y Shares; and FUBS for the exclusive benefit of George M. Kingsbury, Miami, Florida, and for the exclusive benefit of Julio Noltenius, Julio G. Noltenius, and Alicia Noltenius, El Salvador, acting in various capacities for numerous accounts was the owner of record of 3,510 shares (31.60%) and 5,347 shares (48.14%), respectively, of the Emerging Markets Growth Fund--Class C Investment Shares, and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required, by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statement of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid annually for both Funds. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex- dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or FUBS in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX INFORMATION Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended (the "Code") applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. However, the Funds may invest in the stock of certain foreign corporations which would constitute a Passive Foreign Investment Company ("PFIC"). Federal income taxes may be imposed on a Fund upon disposition of PFIC investments. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Investment income received by the Funds from sources within foreign countries may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with many foreign countries that entitle the Funds to reduced tax rates or exemptions on this income. The effective rate of foreign tax cannot be predicted since the amount of Fund assets to be invested within various countries will vary. However, the Funds intend to operate so as to qualify for treaty-reduced tax rates, where applicable. Unless otherwise exempt, shareholders are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Distributions representing net long-term capital gains realized by a Fund, if any, will be taxable as long-term capital gains regardless of the length of time shareholders have held their Shares. If more than 50% of the value of a Fund's assets at the end of the tax year is represented by stock or securities of foreign corporations, the Fund intends to qualify for certain Code stipulations that would allow shareholders to claim a foreign tax credit or deduction on their U.S. income tax returns. The Code may limit a shareholder's ability to claim a foreign tax credit. Furthermore, shareholders who elect to deduct their portion of a Fund's foreign taxes rather than take the foreign tax credit must itemize deductions on their income tax returns. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES OF SHARES First Union Growth Funds offer four classes of shares: Class A Shares, Class B Shares and Class C Shares for individuals and other customers of First Union, and Y Shares for institutional investors. Y Shares of First Union Growth Funds are sold to accounts for which First Union or other financial institutions act in a fiduciary or agency capacity at net asset value, without a sales charge, at a minimum investment of $1,000. Y Shares are not sold pursuant to a Rule 12b-1 plan. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either call FUBS, at 1-800- 3241, or write the Trust. ADDRESSES - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Sub-Adviser to Emerging Markets Growth Fund Marvin & Palmer Associates, Inc. 1201 North Market Street Suite 2300 Wilmington, Delaware 19801- 1165 - -------------------------------------------------------------------------------- Sub-Adviser to International Equity Fund Boston International Advisors, Inc. 75 State Street Boston, Massachusetts 02109 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor G00850-11 (2/95) FIRST UNION BALANCED PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union Balanced Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares', Class B Investment Shares' or Class C Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [LOGO] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 Restricted and Illiquid Securities 1 Temporary Investments 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 1 Lending of Portfolio Securities 3 Reverse Repurchase Agreements 3 Portfolio Turnover 3 Investment Limitations 3 FIRST UNION FUNDS MANAGEMENT 5 - --------------------------------------------------------------- Officers and Trustees 5 Fund Ownership 7 Trustee Compensation 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 9 Shareholder Services Plan 10 DETERMINING NET ASSET VALUE 10 - --------------------------------------------------------------- Determining Market Value of Securities 10 REDEEMING SHARES 11 - --------------------------------------------------------------- Redemption in Kind 11 TAX STATUS 11 - --------------------------------------------------------------- The Fund's Tax Status 11 Shareholders' Tax Status 11 TOTAL RETURN 12 - --------------------------------------------------------------- YIELD 12 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 12 - --------------------------------------------------------------- FINANCIAL STATEMENTS 13 - --------------------------------------------------------------- APPENDIX 14 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Balanced Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to produce long-term total return through capital appreciation, dividends, and interest income. The Fund attempts to achieve this objective by investing in a diversified portfolio of common and preferred stocks, U.S. government and other bonds (which are rated A or higher by Moody's Investors Service, Inc. or Standard & Poor's Ratings Group or which, if unrated, are considered to be of comparable quality by the Fund's investment adviser) and money market instruments. The investment objective cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund invests primarily in common and preferred stocks and other equity securities, bonds, notes, U.S. government securities, repurchase agreements, short-term obligations, and instruments secured by any of these obligations. RESTRICTED AND ILLIQUID SECURITIES The ability of the Board of Trustees ("Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under the Rule) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: the frequency of trades and quotes for the security; the number of dealers willing to purchase or sell the security and the number of other potential buyers; dealer undertakings to make a market in the security; and the nature of the security and the nature of the marketplace trades. TEMPORARY INVESTMENTS The Fund may also invest in temporary investments from time to time for defensive purposes. MONEY MARKET INSTRUMENTS The Fund may invest in money market instruments such as instruments of domestic and foreign banks and savings and loans, if they have capital, surplus, and undivided profits of over $100,000,000, or if the principal amount of the instrument is federally insured. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS As a means of reducing fluctuations in the net asset value of Shares of the Fund, the Fund may attempt to hedge all or a portion of its portfolio through the purchase of put options on portfolio securities and listed put options on financial futures contracts for portfolio securities. The Fund may also write covered call options on its portfolio securities and covered put options to attempt to increase its current income. The aggregate value of the obligations underlying the puts will not exceed 5% of the Fund's net assets. This policy cannot be changed without shareholder approval. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a predetermined price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the put option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the put option will be large enough to offset both the premium paid by the Fund for the put option plus the realized decrease in value of the hedged securities. Alternately, the Fund may exercise its put option to close out the position. To do so, it would enter into a futures contract of the type underlying the option. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and only the premium paid for the contract will be lost. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and thereby insure that the use of such futures contracts is unleveraged. PURCHASING OPTIONS The Fund may purchase both put and call options on its portfolio securities. These options will be used as a hedge to attempt to protect securities which the Fund holds or will be purchasing against decreases or increases in value. The Fund may purchase call and put options for the purpose of offsetting previously written call options of the same series. If the Fund is unable to effect a closing purchase transaction with respect to covered options it has written, the Fund will not be able to sell the underlying securities or dispose of assets held in a segregated account until the options expire or are exercised. The Fund intends to purchase put and call options on currency and other financial futures contracts for hedging purposes. A put option purchased by the Fund would give it the right to assume a position as the seller of a futures contract. A call option purchased by the Fund would give it the right to assume a position as the purchaser of a futures contract. The purchase of an option on a futures contract requires the Fund to pay a premium. In exchange for the premium, the Fund becomes entitled to exercise the benefits, if any, provided by the futures contract, but is not required to take any action under the contract. If the option cannot be exercised profitably before it expires, the Fund's loss will be limited to the amount of the premium and any transaction costs. The Fund currently does not intend to invest more than 5% of its net assets in options transactions. OPTIONS TRADING MARKETS Options which the Fund will trade must be listed on national securities exchanges. Exchanges on which such options currently are traded are the Chicago Board Options Exchange and the New York, American, Pacific and Philadelphia Stock Exchanges ("Exchanges"). LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. The portfolio turnover rates, for the fiscal years ended December 31, 1994 and 1993, were 19% and 11% for the bond portion of the Fund's portfolio, and 16% and 8% for the stock portion of the Fund's portfolio, respectively. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. The use of short sales will allow the Fund to retain certain bonds in its portfolio longer than it would without such sales. To the extent that the Fund receives the current income produced by such bonds for a longer period than it might otherwise, the Fund's investment objective is furthered. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money and engage in reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amounts borrowed. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure to facilitate management of the portfolio by enabling the Fund to, for example, meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Fund will not purchase any securities while any borrowings are outstanding. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. Margin deposits for the purchase and sale of financial futures contracts and related options are not deemed to be a pledge. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, although it may invest in the securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. However, the Fund may enter into futures contracts on financial instruments or currency and sell or buy options on such contracts. RESTRICTED SECURITIES The Fund will not invest more than 10% of its net assets in securities subject to restrictions on resale under the Securities Act of 1933 (except for certain restricted securities which meet the criteria for liquidity established by the Trustees). UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities in accordance with its investment objective, policies and limitations. CONCENTRATION OF INVESTMENTS The Fund will not invest 25% or more of the value of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by U.S. government, its agencies or instrumentalities. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase securities of any one issuer (other than cash, cash items or securities issued or guaranteed by the U.S. government, its agencies or instrumentalities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. The above investment limitations cannot be changed without shareholder approval. The following investment limitations, however, may be changed by Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of its net assets in securities which are illiquid, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities determined by the Trustees not to be liquid. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 25, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; hairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina was the owner of record of approximately 67,604,537 shares (98.44%) of the outstanding Y Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 6, 1995, First Union Brokerage Service, for the exclusive benefit of Naomi Hamuy of Coral Springs, Florida, was the owner of record of approximately 8,864 shares (49.20%), and for the exclusive benefit of Leroy Selby, Jr., of Orlando, Florida, was the owner of record of approximately 1,817 shares (10.08%) of the outstanding Class C Investment Shares of the Fund. TRUSTEES COMPENSATION
AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700
*Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned advisory fees of $4,621,512, $3,425,786, and $2,319,251, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $450,569, $389,044, and $152,802, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $779,584, $597,752, and $427,255, respectively, in administrative service costs. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75% not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A, CLASS B AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B and Class C Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A, Class B and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $102,621 in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $670,202 in distribution services fees on behalf of Class B Investment Shares. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $310 in distribution services fees on behalf of Class C Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $83,641 and $103, respectively, on behalf of Class B Investment Shares and Class C Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market value of the Fund's portfolio securities, other than options, are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the current closing bid and asked prices and for bonds and other fixed income securities as determined by an independent pricing service; .for short-term obligations, according to the mean between bid and asked prices, as furnished by an independent pricing service, or for short-term obligations with remaining maturities of less than 60 days at the time of purchase, at amortized cost unless the Trustees determine this is not fair value; or .at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. The Fund will value futures contracts, options, put and call options on futures and financial futures at their market values established by the Exchanges at the close of option trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing option positions is necessary. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Y Shares for the one-year period ended December 31, 1994 and for the period from April 1, 1991 (start of performance) to December 31, 1994 were (2.15)% and 8.30%, respectively. The Fund's average annual total returns for Class A Investment Shares for the one-year period ended December 31, 1994 and for the period from June 6, 1991 (start of performance) to December 31, 1994 were (7.03)% and 6.05%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1994 and for the period from January 25, 1993 (start of performance) to December 31, 1994 were (7.85)% and 0.64%%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from September 2, 1994 (start of performance) to December 31, 1994 was (4.53)%. The average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of shares owned at the end of the period by the net asset value per share at the end of the period. The number of shares owned at the end of the period is based on the number of shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional shares, assuming the quarterly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of Shares redeemed. Cumulative total return reflects the Class C Investment Shares' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load, and any contingent deferred sales charge, if applicable. The Class C Investment Shares' total return is representative of only 4 months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 4.84%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 4.36%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 3.82%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1994 was 3.82%. The yield for all classes of shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC earned by any class of Shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LEHMAN BROTHERS GOVERNMENT/CORPORATE (TOTAL) index is comprised of approximately 5,000 issues, which include: non-convertible bonds publicly issued by the U.S. government or its agencies; corporate bonds guaranteed by the U.S. government and quasi-federal corporations; and publicly issued, fixed rate, non-convertible domestic bonds of companies in industry, public utilities, and finance. The average maturity of these bonds approximates nine years. Tracked by Lehman Brothers, Inc., the index calculates total returns for one month, three month, twelve month, and ten year periods and year-to-date. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .SALOMON BROTHERS AAA-AA CORPORATE index calculates total returns of approximately 775 issues which include long-term, high grade domestic corporate taxable bonds, rated AAA-AA with maturities of twelve years or more and companies in industry, public utilities, and finance. .LEHMAN BROTHERS INTERMEDIATE GOVERNMENT/CORPORATE BOND INDEX: An unmanaged index comprised of all the bonds issued by the Lehman Brothers Government/Corporate Bond Index with maturities between 1 and 9.99 years. Total return is based on price appreciation/depreciation and income as a percentage of the original investment. Indices are rebalanced monthly by market capitalization. .DOW JONES INDUSTRIAL AVERAGE (DJIA): An unmanaged index representing share prices of major industrial corporations, public utilities, and transportation companies. Produced by Dow Jones & Company, it is the oldest and most widely quoted of all market indicators. The Dow represents about 25% of the NYSE market capitalization and less than 2% of NYSE issues. It is a price-weighted arithmetic average, with the divisor adjusted for stock splits. The index is calculated on both a price change and total return basis. .STANDARD AND POOR'S DAILY STOCK PRICE INDEX OF 500 COMMON STOCKS, a composite index of common stocks in industry, transportation, financial, and public utility companies, can be used to compare to the total returns of funds whose portfolios are invested primarily in common stocks. In addition, the Standard & Poor's Index assumes reinvestments of all dividends paid by stocks listed on its index. Taxes due on any of these distributions are not included, nor are brokerage or other fees calculated in the Standard & Poor's figures. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Balanced Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Growth and Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than debt in higher rated categories. MOODY'S INVESTORS SERVICE, INC. CORPORATE BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. G00850-23 (2/95) FIRST UNION UTILITY PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union Utility Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares', Class B Investment Shares' or Class C Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [LOGO] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Restricted and Illiquid Securities 1 When-Issued and Delayed Delivery Transactions 1 Lending of Portfolio Securities 2 Reverse Repurchase Agreements 2 Options and Futures Transactions 2 Portfolio Turnover 3 Investment Limitations 3 FIRST UNION FUNDS MANAGEMENT 5 - --------------------------------------------------------------- Officers and Trustees 5 Fund Ownership 7 Trustees Compensation 8 Trustee Liability 8 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 8 BROKERAGE TRANSACTIONS 9 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 10 Shareholder Services Plan 11 DETERMINING NET ASSET VALUE 11 - --------------------------------------------------------------- Determining Market Value of Securities 11 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 12 - --------------------------------------------------------------- The Fund's Tax Status 12 Shareholders' Tax Status 12 TOTAL RETURN 12 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 13 - --------------------------------------------------------------- FINANCIAL STATEMENTS 14 - --------------------------------------------------------------- APPENDIX 14 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Utility Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is high current income and moderate capital appreciation. The Fund invests primarily in a diversified portfolio of equity and debt securities issued by utility companies. The investment objective cannot be changed without approval of shareholders. U.S. GOVERNMENT OBLIGATIONS The types of U.S. government obligations in which the Fund may invest generally include direct obligations of the U.S. Treasury (such as U.S. Treasury bills, notes, and bonds) and obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: the full faith and credit of the U.S. Treasury; the issuer's right to borrow from the U.S. Treasury; the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks and Banks for Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal Home Loan Mortgage Corporation; Federal National Mortgage Association; Government National Mortgage Association; and Student Loan Marketing Association. RESTRICTED AND ILLIQUID SECURITIES The ability of the Board of Trustees ("Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities eligible for resale (under the Rule) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: the frequency of trades and quotes for the security; the number of dealers willing to purchase or sell the security and the number of other potential buyers; dealer undertakings to make a market in the security; and the nature of the security and the nature of marketplace trades. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. - -------------------------------------------------------------------------------- LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be repurchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. OPTIONS AND FUTURES TRANSACTIONS Options which the Fund will trade must be listed on national securities exchanges. Exchanges on which such options currently are traded are the Chicago Board Options Exchange and the New York, American, Pacific and Philadelphia Stock Exchanges ("Exchanges"). PURCHASING PUT AND CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase put options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at an undetermined price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put and call options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the put option will increase in value. In such an event, the Fund will normally close out its option by selling an identical put option. If the hedge is successful, the proceeds received by the Fund upon the sale of the put option will be large enough to offset both the premium paid by the Fund for the put option plus the realized decrease in value of the hedged securities. Alternately, the Fund may exercise its put option to close out the position. To do so, it would enter into a futures contract of the type underlying the option. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and only the premium paid for the contract will be lost. PURCHASING OPTIONS The Fund may purchase both put and call options on its portfolio securities. These options will be used as a hedge to attempt to protect securities which the Fund holds or will be purchasing against decreases or increases in value. The Fund may purchase call and put options for the purpose of offsetting previously written call and put options of the same series. If the Fund is unable to effect a closing purchase transaction with respect to covered options it has written, the Fund will not be able to sell the underlying securities or dispose of assets held in a segregated account until the options expire or are exercised. The Fund intends to purchase put and call options on currency and other financial futures contracts for hedging purposes. A put option purchased by the Fund would give it the right to assume a position as the seller of a futures contract. A call option purchased by the Fund would give it the right to assume a position as the purchaser of a futures contract. The purchase of an option on a futures contract requires the Fund to pay a premium. In exchange for the premium, the Fund becomes entitled to exercise the benefits, if any, provided by the futures contract, but is not required to take any action under the contract. If the option cannot be exercised profitably before it expires, the Fund's loss will be limited to the amount of the premium and any transaction costs. The Fund currently does not intend to invest more than 5% of its net assets in options transactions. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and thereby insure that the use of such futures contracts is unleveraged. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objectives. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of turnover exceeding 85%. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the portfolio turnover rate for the Fund was 23%. INVESTMENT LIMITATIONS CONCENTRATION OF INVESTMENTS The Fund will not invest more than 25% of its total assets (valued at the time of investment) in securities of companies engaged principally in any one industry other than the utilities industry, except that this restriction does not apply to cash or cash items and securities issued or guaranteed by the United States government or its agencies or instrumentalities. SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of transactions. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money directly or through reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amount borrowed and except to the extent that the Fund may enter into futures contracts. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure to facilitate management of the portfolio by enabling the Fund to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. However, the Fund may enter into futures contracts on financial instruments or currency and sell or buy options on such contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets, except portfolio securities up to 15% of the value of its total assets. This shall not prevent the Fund from purchasing or holding corporate or government bonds, debentures, notes, certificates of indebtedness or other debt securities of an issuer, repurchase agreements, or other transactions which are permitted by the Fund's investment objectives and policies or the Trust's Declaration of Trust. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objectives, policies, and limitations. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options and segregation or collateral arrangements made in connection with options activities. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests in real estate, although it may invest in securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase the securities of any issuer (other than cash, cash items, or securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities and repurchase agreements collateralized by such securities) if, as a result, more than 5% of the value of its total assets would be invested in the securities of that issuer. The Fund will not acquire more than 10% of the outstanding voting securities of any one issuer. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material changes in these limitations become effective. INVESTING IN RESTRICTED SECURITIES The Fund will not invest more than 10% of its total assets in securities subject to restrictions on resale under the Securities Act of 1933, except for commercial paper issued under Section 4(2) of the Securities Act of 1933 and certain other restricted securities which meet the criteria for liquidity as established by the Trustees. To comply with certain state restrictions, the Fund will limit these transactions to 5% of its total assets. (If state restrictions change, this latter restriction may be revised without shareholder approval or notification.) INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid securities, including repurchase agreements providing for settlement more than seven days after notice, non-negotiable time deposits, and certain restricted securities not determined by the Trustees to be liquid. INVESTING TO EXERCISE CONTROL The Fund will not purchase securities of an issuer for the purpose of exercising control or management. INVESTING IN PUT OPTIONS The Fund will not purchase put options on securities, unless the securities are held in the Fund's portfolio and not more than 5% of the Fund's total assets would be invested in premiums on open put option positions. WRITING COVERED CALL OPTIONS The Fund will not write call options on securities unless the securities are held in the Fund's portfolio or unless the Fund is entitled to them in deliverable form without further payment or after segregating cash in the amount of any further payment. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of its total assets in securities of issuers which have records of less than three years of continuous operations, including their predecessors. INVESTING IN WARRANTS The Fund will not invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities. To comply with certain state restrictions, the Fund will limit its investment in such warrants not listed on the New York or American Stock Exchanges to 2% of its net assets. (If state restrictions change, this latter restriction may be revised without notice to shareholders.) For purposes of this investment restriction, warrants acquired by the Fund in units or attached to securities may be deemed to be without value. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and, therefore, any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. To comply with registration requirements in certain states, the Fund (a) will limit the aggregate value of the assets underlying covered call options or put options written by the Fund to not more than 25% of its net assets, (b) will limit the premiums paid for options purchased by the Fund to 20% of its net assets, and (c) will limit the margin deposits on futures contracts entered into by the Fund to 5% of its net assets. (If state requirements change, these restrictions may be revised without shareholder notification.) The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 321 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 563,915 shares (97.41%) of the outstanding Y Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the International Equity Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Elsie B. Strom and Lewis F. Strom, both of Bennettsville, South Carolina, owned approximately 5,470 shares (38.00%); FUBS, for the exclusive benefit of Laura Alyce Hulbert and Ronald F. Hulbert, both of Charlotte, North Carolina, owned approximately 2,974 shares (20.66%); FUBS, for the exclusive benefit of Charlotte A. Hall, Maggie, North Carolina, owned approximately 1,098 shares (7.63%); and FUBS, for the exclusive benefit of Evelyn L. Smith and Greg Smith, both of Hapeville, Georgia, owned approximately 1,090 shares (7.57%). - -------------------------------------------------------------------------------- TRUSTEES COMPENSATION
AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700
*Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Adviser earned advisory fees of $153,458, of which $152,038 were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Fund paid $66,294 in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $104,384 in administrative service costs, of which $104,384 were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A, CLASS B AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B and Class C Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A, Class B and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $9,658 in distribution services fees on behalf of Class A Investment Shares. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $169,007 in distribution services fees on behalf of Class B Investment Shares. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $232 in distribution services fees on behalf of Class C Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $24,141 and $77, respectively, on behalf of Class B Investment Shares and Class C Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market values of the Fund's portfolio securities, other than options, are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the last closing bid and asked prices, and for bonds and other fixed income securities, as determined by an independent pricing service; .for unlisted equity securities, the latest bid prices; or .for short-term obligations, according to the mean between bid and asked prices as furnished by an independent pricing service, or for short-term obligations with remaining maturities of 60 days or less at the time of purchase, at amortized cost or at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. The Fund will value futures contracts, options, put and call options on futures and financial futures at their market values established by the Exchanges at the close of option trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing option positions is necessary. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's cumulative total return for Y Shares from February 28, 1994 (start of performance) to December 31, 1994 was (1.55%). The Fund's cumulative total return for Class A Investment Shares from January 4, 1994 (start of performance) to December 31, 1994 was (10.10%). The Fund's cumulative total return for Class B Investment Shares from January 4, 1994 (start of performance) to December 31, 1994 was (10.93%). The Fund's cumulative total return for Class C Investment Shares from September 2, 1994 (start of performance) to December 31, 1994 was (3.20%). Cumulative total return reflects each class's total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load, if applicable. Y Shares' total return is representative of only 9 months of Fund activity since the start of performance. Class A Shares' and Class B Shares' total returns are representative of only 11 months of Fund activity since the start of performance. Class C Shares' total return is representative of only 8 months of Fund activity since the (start of performance). YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 5.16%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 4.67%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 4.14%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1994 was 4.14%. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by any class of shares over a thirty-day period by the offering price per Share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of shares, the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ("LIPPER"), an independent mutual fund rating service, ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specified period of time. From time to time, the Fund will quote its Lipper ranking in the "utility funds" category in advertising and sales literature. .DOW JONES INDUSTRIAL AVERAGE ("DJIA") represents share prices of selected blue chip industrial corporations as well as public utility and transportation companies. The DJIA indicates daily changes in the average price of stocks in any of its categories. It also reports total sales for each group of industries. Because it represents the top corporations of America, the DJIA is a leading economic indicator for the stock market as a whole. .STANDARD & POOR'S UTILITY INDEX is an unmanaged index of common stocks from forty different utilities. This index indicates daily changes in the price of the stocks. The index also provides figures for changes in price from the beginning of the year to date, and for a twelve month period. .DOW JONES UTILITY INDEX is an unmanaged index comprised of fifteen utility stocks that tracks changes in price daily and over a six month period. The index also provides the highs and lows for each of the past five years. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .STANDARD & POOR'S DAILY STOCK PRICE INDEX OF 500 COMMON STOCKS, a composite index of common stocks in industry, transportation, and financial and public utility companies, can be used to compare to the total returns of funds whose portfolios are invested primarily in common stocks. In addition, the Standard & Poor's Index assumes reinvestments of all dividends paid by stocks listed on its index. Taxes due on any of these distributions are not included, nor are brokerage or other fees calculated in the Standard & Poor's figures. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Utility Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Growth and Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. CORPORATE BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. BAA--Bonds which are rated BAA are considered as medium-grade obligations, (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATING DEFINITIONS A-1--This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation. A-2--Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1. MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATING DEFINITIONS PRIME-1--Issuers rated PRIME-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. PRIME-1 repayment capacity will normally be evidenced by the following characteristics: .Leading market positions in well established industries. .High rates of return on funds employed. .Conservative capitalization structures with moderate reliance on debt and ample asset protection. .Broad margins in earnings coverage of fixed financial markets and assured sources of alternate liquidity. .Well-established access to a range of financial markets and assured sources of alternate liquidity. PRIME-2--Issuers rated PRIME-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above, but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. G00850-17 (2/95) 1 FIRST UNION VALUE PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union Value Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares', Class B Investment Shares' or Class C Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [LOGO] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 When-Issued and Delayed Delivery Transactions 2 Lending of Portfolio Securities 2 Reverse Repurchase Agreements 2 Options and Futures Transactions 2 Portfolio Turnover 3 Investment Limitations 3 FIRST UNION FUNDS MANAGEMENT 5 - --------------------------------------------------------------- Officers and Trustees 5 Fund Ownership 7 Trustees Compensation 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 10 Shareholder Services Plan 10 DETERMINING NET ASSET VALUE 10 - --------------------------------------------------------------- Determining Market Value of Securities 10 REDEEMING SHARES 11 - --------------------------------------------------------------- Redemption in Kind 11 TAX STATUS 11 - --------------------------------------------------------------- The Fund's Tax Status 11 Shareholders' Tax Status 11 TOTAL RETURN 12 - --------------------------------------------------------------- YIELD 12 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 12 - --------------------------------------------------------------- FINANCIAL STATEMENTS 13 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Value Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." In addition, the name of the Fund was changed from "The Salem Growth Portfolio" to "The Salem Value Portfolio" on December 19, 1991. Shares of the Fund are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's primary investment objective is long-term capital growth. Current income is a secondary objective. The Fund pursues these investment objectives by investing primarily in equity securities of companies with prospects for growth in earnings and dividends. The investment objectives cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund may invest in common stocks, preferred stocks, corporate bonds, debentures, notes, warrants, and put options on stocks. CORPORATE DEBT SECURITIES Corporate debt securities may bear fixed, fixed and contingent, or variable rates of interest. They may involve equity features such as conversion or exchange rights, warrants for the acquisition of common stock of the same or a different issuer, participations based on revenues, sales, or profits, or the purchase of common stock in a unit transaction (where corporate debt securities and common stock are offered as a unit). RESTRICTED SECURITIES The Fund expects that any restricted securities would be acquired either from institutional investors who originally acquired the securities in private placements or directly from the issuers of the securities in private placements. Restricted securities and securities that are not readily marketable may sell at a discount from the price they would bring if freely marketable. MONEY MARKET INSTRUMENTS The Fund may invest in the following money market instruments: instruments of domestic banks and savings and loans if they have capital, surplus, and undivided profits of over $100,000,000, or if the principal amount of the instrument is insured in full by the Bank Insurance Fund ("BIF"), or the Savings Association Insurance Fund ("SAIF"), both of which are administered by the Federal Deposit Insurance Corporation ("FDIC"); and prime commercial paper (rated A-1 by Standard & Poor's Ratings Group, or Prime-1 by Moody's Investors Service, Inc.). U.S. GOVERNMENT OBLIGATIONS The types of U.S. government obligations in which the Fund may invest generally include obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: Farm Credit System, including the National Bank for Cooperatives, Farm Credit Banks and Banks for Cooperatives; Farmers Home Administration; Federal Home Loan Banks; Federal Home Loan Mortgage Corporation; Federal National Mortgage Association; Government National Mortgage Association; and Student Loan Marketing Association. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield of for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be repurchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. OPTIONS AND FUTURES TRANSACTIONS Options which the Fund will trade must be listed on national securities exchanges. Exchanges on which such options currently are traded are the Chicago Board Options Exchange and the New York, American, Pacific and Philadelphia Stock Exchanges ("Exchanges"). PURCHASING PUT AND CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at an undetermined price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund would purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the put option will increase in value. In such an event, the Fund will normally close out its option by selling an identical put option. If the hedge is successful, the proceeds received by the Fund upon the sale of the put option will be large enough to offset both the premium paid by the Fund for the put option plus the realized decrease in value of the hedged securities. Alternately, the Fund may exercise its put option to close out the position. To do so, it would enter into a futures contract of the type underlying the option. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and only the premium paid for the contract will be lost. - -------------------------------------------------------------------------------- PURCHASING OPTIONS The Fund may purchase call and put options for the purpose of offsetting previously written call and put options of the same series. If the Fund is unable to effect a closing purchase transaction with respect to covered option it has written, the Fund will not be able to sell the underlying securities or dispose of assets held in a segregated account until the options expire or are exercised. The Fund intends to purchase put and call options on currency and other financial futures contracts for hedging purposes. A put option purchased by the Fund would give it the right to assume a position as the seller of a futures contract. A call option purchased by the Fund would give it the right to assume a position as the purchaser of a futures contract. The purchase of an option on a futures contract requires the Fund to pay a premium. In exchange for the premium, the Fund becomes entitled to exercise the benefits, if any, provided by the futures contract, but is not required to take any action under the contract. If the option cannot be exercised profitably before it expires, the Fund's loss will be limited to the amount of the premium and any transaction costs. The Fund currently does not intend to invest more than 5% of its net assets in options transactions. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. When the Fund purchases futures contracts, an amount of cash and cash equivalents, equal to the underlying commodity value of the futures contracts (less any related margin deposits), will be deposited in a segregated account with the Fund's custodian (or the broker, if legally permitted) to collateralize the position and thereby insure that the use of such futures contracts is unleveraged. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objectives. The portfolio turnover rates for the fiscal years ended December 31, 1994 and 1993 were 70% and 46%, respectively. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of transactions. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes and then only in amounts not in excess of 10% of the value of its total assets; provided that while borrowings exceed 5% of the Fund's total assets, any such borrowings will be repaid before additional investments are made. The Fund will not purchase any securities while borrowings in excess of 5% of the value of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry. However, the Fund may at times invest 25% or more of the value of its total assets in securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. However, the Fund may enter into futures contracts on financial instruments or currency and sell or buy options on such contracts. RESTRICTED SECURITIES The Fund will not invest more than 10% of the value of its net assets in securities subject to restrictions on resale under federal securities laws. PURCHASING MORE THAN 10% OF ANY ISSUER The Fund will not purchase more than 10% of any class of outstanding voting securities of any issuer. INVESTING TO EXERCISE CONTROL The Fund will not purchase securities for the purpose of exercising control over the issuer of securities. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except that it may purchase or hold corporate or government bonds, debentures, notes, certificates of indebtedness or other debt securities of an issuer, repurchase agreements, or other transactions which are permitted by the Fund's investment objectives and policies or the Declaration of Trust, or lend portfolio securities valued at not more than 5% of its total assets to broker/dealers. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objectives, policies, and limitations. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 10% of the value of total assets at the time of the borrowing. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests in real estate, although it may invest in securities of companies whose business involved the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase the securities of any issuer (other than cash, cash items, or securities issued or guaranteed by U.S. government, its agencies, or instrumentalities) if, as a result, more than 5% of the value of its total assets would be invested in the securities of that issuer. ACQUIRING SECURITIES The Fund will not purchase more than 10% of the voting securities of any one issuer. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, other mineral exploration or development programs, or leases, although it may purchase the publicly traded securities of companies engaging in such activities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. The above investment limitations cannot be changed without shareholder approval. The following limitation, however, may be changed by the Board of Trustees (the "Trustees") without shareholder approval. Shareholders will be notified before any material changes in these limitations become effective. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of its total assets in securities of unseasoned issuers, including their predecessors, that have been in operation for less than three years. INVESTING IN WARRANTS The Fund will not invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities. To comply with certain state restrictions, the Fund will limit its investment in such warrants not listed on the New York or American Stock Exchange to 2% of its net assets. (If state restrictions change, this latter restriction may be revised without notice to shareholders.) For purposes of this investment restriction, warrants acquired by the Fund in units or attached to securities may be deemed to be without value. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, sell securities short, invest in reverse repurchase agreements in excess of 5% of the value of its net assets, or invest more than 5% of its net assets in the securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. In addition, the Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan, having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment, to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 312 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 25,570,079 shares (90.57%) and 2,680,070 shares (8.80%) of Value Fund-Y Shares. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 6, 1995, First Union Brokerage Service, for the exclusive benefit of: Benjamin Hamuy of Coral Springs Florida, was the owner of record of approximately 5,992 shares (19.64%); William H. Smith of Evans, Georgia, was the owner of record of approximately 1,807 shares (5.92%); and C. Wilson Construction Company, Profit Sharing Plan, Bartow, Florida, was the owner of record of approximately 4,262 shares (13.97%) of Value Fund-Class C Investment Shares. First Union National Bank of Florida, for the exclusive benefit of St. Elmo Dowling IRA, Winter Garden, Florida, was the owner of record of approximately 1,698 shares (5.57%) of Value Fund-Class C Investment Shares. TRUSTEES COMPENSATION
AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700
*Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned advisory fees of $3,850,673, $3,016,457, and $2,208,618, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $1,437,338, $894,400, and $642,338, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $649,487, $526,836, and $407,134 in administrative service costs, of which $17,263, were voluntarily waived in 1992. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. - -------------------------------------------------------------------------------- DISTRIBUTION PLANS (CLASS A, CLASS B AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B and Class C Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission ("SEC") pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A, Class B and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A, Class B and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $473,347, in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $621,330 in distribution services fees on behalf of Class B Investment Shares. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $716 in distribution services fees on behalf of Class C Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $83,225 and $239 on behalf of Class B Investment Shares and Class C Investment Shares, respectively. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market values of the Fund's portfolio securities, other than options, are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the current closing bid and asked prices and for bonds and other fixed income securities as determined by an independent pricing service; .for unlisted equity securities, the latest bid prices; or .for short-term obligations, according to the mean between bid and asked prices as furnished by an independent pricing service, or for short-term obligations with remaining maturities of 60 days or less at the time of purchase, at amortized cost or at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. The Fund will value futures contracts, options, put and call options on futures and financial futures at their market values established by the Exchanges at the close of option trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing option positions is necessary. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional Shares. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Y Shares for the one-year period ended December 31, 1994 and for the period from December 31, 1990, (start of performance) to December 31, 1994 were 2.07% and 11.06%, respectively. The Fund's average annual total returns for Class A Investment Shares for the one-year and five-year periods ended December 31, 1994 and for the period from April 12, 1985 (start of performance) to December 31, 1994 were (2.98%), 6.71%, and 11.06%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1994 and for the period from January 25, 1993 (start of performance) to December 31, 1994 were (3.80%) and 3.15%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from September 2, 1994 (start of performance) to December 31, 1994 was (4.40%). The average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of shares owned at the end of the period by the net asset value per share at the end of the period. The number of shares owned at the end of the period is based on the number of shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional shares, assuming a quarterly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of the Shares redeemed. Cumulative total returns reflects the Class C Investment Shares' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. The Class C Investment Shares' total return is representative of only four months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 3.45%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 3.04%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 2.42%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1994 was 2.42%. The yield for all classes of shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC) earned by any class of Shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ("LIPPER"), an independent mutual fund rating service, ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specified period of time. From time to time, the Fund will quote its Lipper ranking in the "growth funds" category in advertising and sales literature. .LIPPER GROWTH FUND AVERAGE is an average of the total returns for 251 growth funds tracked by Lipper Analytical Services, Inc., an independent mutual fund rating service. .LIPPER GROWTH FUND INDEX is an average of the net asset-valuated total returns for the top 30 growth funds tracked by Lipper Analytical Services, Inc., an independent mutual fund rating service. .DOW JONES INDUSTRIAL AVERAGE ("DJIA") is an unmanaged index representing share prices of major industrial corporations, public utilities, and transportation companies. Produced by the Dow Jones & Company, it is cited as a principal indicator of market conditions. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .STANDARD & POOR'S DAILY STOCK PRICE INDEX OF 500 COMMON STOCKS, a composite index of common stocks in industry, transportation, financial, and public utility companies, can be used to compare to the total returns of funds whose portfolios are invested primarily in common stocks. In addition, the Standard & Poor's Index assumes reinvestments of all dividends paid by stocks listed on its index. Taxes due on any of these distributions are not included, nor are brokerage or other fees calculated in the Standard & Poor's figures. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Value Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Growth and Income Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. G00850-27 (2/95) PROSPECTUS FIRST UNION TAX-FREE FUNDS Y SHARES FEBRUARY 28, 1995 FIRST UNION - --------------------------- TAX-FREE --------------------------- - --------------------------- FUNDS --------------------------- Portfolios of First Union Funds Y SHARES - ------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes one diversified and five non-diversified Tax-Free Funds, three diversified Growth and Income Funds, three diversified Income Funds, two diversified Growth Funds, and three diversified Money Market Funds. They are: Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly First Union Insured Tax Free Portfolio). Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio; Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. This prospectus provides you with information specific to the Y Shares of First Union Tax-Free Funds. It concisely describes the information which you should know before investing in Y Shares of any of the First Union Tax-Free Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Tax-Free Fund in its Statement of Additional Information dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-2584. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. For a description of the nature and limitations of municipal bond insurance, see "Municipal Bond Insurance," page 15. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - ------------------------ TABLE OF ------------------------ - ------------------------ CONTENTS ------------------------ Summary 2 How to Redeem Shares 24 - -------------------------------------- -------------------------------------- Summary of Fund Expenses 4 Management of First Union Funds 24 - -------------------------------------- -------------------------------------- Financial Highlights 6 Fees and Expenses 26 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 12 Shareholder Rights and Privileges 27 - -------------------------------------- -------------------------------------- Other Investment Policies 16 Distributions and Taxes 29 - -------------------------------------- -------------------------------------- Shareholder Guide 21 Tax Information 29 - -------------------------------------- -------------------------------------- How to Buy Shares 22 Other Classes of Shares 33 - -------------------------------------- -------------------------------------- How to Convert Your Investment from Shareholder Reports 33 One First Union Fund to Another -------------------------------------- First Union Fund 23 - -------------------------------------- Addresses 36 -------------------------------------- - ------------------------ SUMMARY ------------------------ - ------------------------ ------------------------ DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Tax-Free Fund currently offers three classes of shares: Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), and Y Shares. Class A Shares and Class B Shares are sold to individuals and other customers of First Union (the "Adviser"). Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates only to Y Shares ("Shares") of the First Union Tax-Free Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following six Tax- Free Funds: . First Union Florida Municipal Bond Portfolio ("Florida Municipal Bond Fund")--seeks current income exempt from federal regular income tax consistent with preservation of capital. In addition, the Fund intends to qualify as an investment exempt from the Florida state intangibles tax; . First Union Georgia Municipal Bond Portfolio ("Georgia Municipal Bond Fund")--seeks current income exempt from federal regular income tax and Georgia state income tax, consistent with preservation of capital; . First Union North Carolina Municipal Bond Portfolio ("North Carolina Municipal Bond Fund")-- seeks current income exempt from federal regular income tax and North Carolina state income tax, consistent with preservation of capital. In addition, the Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax; . First Union South Carolina Municipal Bond Portfolio ("South Carolina Municipal Bond Fund")-- seeks current income exempt from federal regular income tax and South Carolina state income tax; . First Union Virginia Municipal Bond Portfolio ("Virginia Municipal Bond Fund")--seeks current income exempt from federal regular income tax and Virginia state income tax, consistent with preservation of capital; and . First Union High Grade Tax Free Portfolio ("High Grade Tax Free Fund")-- seeks to provide a high level of federally tax-free income that is consistent with preservation of capital. The First Union Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Portfolios may be referred to herein as the "Single State Municipal Bond Funds." INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Y Shares of any of the Tax-Free Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares."
- -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION TAX-FREE FUNDS Y SHARES North South Florida Georgia Carolina Carolina Virginia High Grade Municipal Municipal Municipal Municipal Municipal Tax Free Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund Fund --------- --------- --------- --------- --------- ---------- Y Shares-- Shareholder Transaction Expenses Maximum Sales Load Imposed on Pur- chases (as a percentage of offering price)........................... None None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a per- centage of offering price)............... None None None None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applica- ble)............................. None None None None None None Redemption Fee (as a percentage of amount redeemed, if applicable).. None None None None None None Exchange Fee...................... None None None None None None Annual Y Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1). 0.01% 0.00% 0.19% 0.00% 0.00% 0.50% 12b-1 Fees........................ None None None None None None Total Other Expenses (after waiver and reimbursement) (2)............... 0.48% 0.45% 0.44% 0.40% 0.50% 0.33% Total Y Shares Operating Expenses (3)................. 0.49% 0.45% 0.63% 0.40% 0.50% 0.83%
(1) The management fees, except for the High Grade Tax Free Fund, have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee for each Fund is 0.50%. (2) Total Other Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds are expected to be 0.65%, 2.06%, 0.50%, 5.82% and 3.04%, respectively, absent the voluntary waivers by the administrator and reimbursement of other operating expenses by the Adviser for Georgia, South Carolina and Virginia Municipal Bond Funds. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (3) Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds' and High Grade Tax Free Fund's Total Y Shares Annual Operating Expenses were 0.39%, 0.31%, 0.59%, 0.00%, 0.28%, and 0.76%, respectively, for the year ended December 31, 1994. Total Y Share Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds and High Grade Tax Free Fund absent the voluntary waiver of the management fee and reimbursement of other operating expenses of Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds by the Adviser and the voluntary waiver of the administrative fee, except for High Grade Tax Free Fund, by the administrator were 1.15%, 3.39%, 0.98%, 10.46%, 4.89% and 0.77%, respectively, for the year ended December 31, 1994. The Annual Y Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Y Shares expected Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds would be 1.15%, 2.56%, 1.00%, 6.32%, and 3.54%, respectively, absent the voluntary waivers and reimbursements described above in notes 1 and 2. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION TAX-FREE FUNDS Y SHARES The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) re- demption at the end of each time period. The Funds charge no redemption fees for Y Shares. Florida Municipal Bond Fund................. $ 5 $16 $27 $ 62 Georgia Municipal Bond Fund................. $ 5 $14 $25 $ 57 North Carolina Municipal Bond Fund.......... $ 6 $20 $35 $ 79 South Carolina Municipal Bond Fund.......... $ 4 $13 $22 $ 51 Virginia Municipal Bond Fund................ $ 5 $16 $28 $ 63 High Grade Tax Free Fund.................... $ 8 $26 $46 $103 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Y Shares of the Funds. The Funds also offer two additional classes of shares called Class A Shares and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Class A Shares and Class B Shares are subject to certain of the same expenses as Y Shares. However, Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and Class B Shares are subject to a 12b-1 fee of 0.75 of 1% and a shareholder service fee of 0.25 of 1%. In addition, Class A Shares bear a maximum front-end sales load of 4.75% and Class B Shares bear a maximum contingent deferred sales charge of 5.00%. See "Other Classes of Shares." - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Florida Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Y Shares Shares Shares ------------ --------------- ----------------- Year Ended Year Ended Year Ended December 31, December 31, December 31, ------------ --------------- ----------------- 1994*** 1994 1993* 1994 1993** - ------------------------ ------------ ------ ------ ------- ------- Net asset value, begin- ning of period $ 9.99 $10.34 $10.00 $10.34 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.42 0.49 0.22 0.43 0.20 - ------------------------ Net realized and unrealized gain (loss) on investments (1.07) (1.42) 0.34 (1.42) 0.34 - ------------------------ ------ ------ ------ ------ ------ Total from investment operations (0.65) (0.93) 0.56 (0.99) 0.54 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.42) (0.49) (0.22) (0.43) (0.20) - ------------------------ ------ ------ ------ ------ ------ Net asset value, end of period $ 8.92 $ 8.92 $10.34 $ 8.92 $10.34 - ------------------------ ------ ------ ------ ------ ------ Total return+ (6.54%) (9.14%) 5.63% (9.66%) 5.40% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.39%(b) 0.64% 0.25%(b) 1.22% 0.75%(b) - ------------------------ Net investment income 5.54%(b) 5.19% 4.92%(b) 4.61% 4.46%(b) - ------------------------ Expense waiver/reimbursement (a) 0.76%(b) 0.76% 1.58%(b) 0.76% 1.58%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $1,764 $8,689 $8,110 $24,756 $18,383 - ------------------------ Portfolio turnover rate 72% 72% 3% 72% 3% - ------------------------
* Reflects operations for the period from July 6, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. *** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Georgia Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995 on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Fund's Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Y Shares Shares Shares ------------ ---------------- ---------------- Year Ended Year Ended Year Ended December 31, December 31, December 31, ------------ ---------------- ---------------- 1994* 1994 1993** 1994 1993** - ------------------------ ------------ ------ ------- ------ ------- Net asset value, begin- ning of period $ 9.83 $10.19 $10.00 $10.19 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.42 0.48 0.201 0.43 0.179 - ------------------------ Net realized and unrealized gain (loss) on investments (1.09) (1.45) 0.193 (1.45) 0.193 - ------------------------ ------ ------ ------- ------ ------- Total from investment operations (0.67) (0.97) 0.394 (1.02) 0.372 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.42) (0.48) (0.201) (0.43) (0.179) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions -- -- (0.003) -- (0.003) - ------------------------ ------ ------ ------- ------ ------- Total distributions (0.42) (0.48) (0.204) (0.43) (0.182) - ------------------------ ------ ------ ------- ------ ------- Net asset value, end of period $ 8.74 $ 8.74 $10.19 $ 8.74 $10.19 - ------------------------ ------ ------ ------- ------ ------- Total return+ (6.87%) (9.64%) 3.96% (10.15%) 3.74% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.31%(b) 0.53% 0.25%(b) 1.13% 0.75%(b) - ------------------------ Net investment income 5.68%(b) 5.26% 4.71%(b) 4.66% 4.15%(b) - ------------------------ Expense waiver/reimbursement (a) 3.08%(b) 3.08% 6.57%(b) 3.08% 6.57%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $284 $1,387 $817 $6,912 $3,692 - ------------------------ Portfolio turnover rate 147% 147% 15% 147% 15% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union North Carolina Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Y Investment Investment Shares Shares Shares ------------ ---------------- ----------------- Year Ended Year Ended Year Ended December 31, December 31, December 31, ------------ ---------------- ----------------- 1994* 1994 1993** 1994 1993** - ------------------------ ------------ ------ ------- ------- ------- Net asset value, begin- ning of period $10.31 $10.61 $10.00 $10.61 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.43 0.49 0.46 0.44 0.42 - ------------------------ Net realized and unrealized gain (loss) on investments (1.15) (1.45) 0.64 (1.45) 0.64 - ------------------------ ------ ------ ------ ------ ------ Total from investment operations (0.72) (0.96) 1.10 (1.01) 1.06 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.43) (0.49) (0.46) (0.44) (0.42) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions -- -- (0.03) -- (0.03) - ------------------------ ------ ------ ------ ------ ------ Total distributions (0.43) (0.49) (0.49) (0.44) (0.45) - ------------------------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.16 $ 9.16 $10.61 $ 9.16 $10.61 - ------------------------ ------ ------ ------ ------ ------ Total return+ (7.03%) (9.12%) 11.28% (9.64%) 10.80% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.59%(b) 0.79% 0.32%(b) 1.37% 0.79%(b) - ------------------------ Net investment income 5.58%(b) 5.11% 4.91%(b) 4.53% 4.47%(b) - ------------------------ Expense waiver/reimbursement (a) 0.39%(b) 0.39% 0.93%(b) 0.39% 0.95%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $642 $7,979 $12,739 $44,616 $45,168 - ------------------------ Portfolio turnover rate 126% 126% 57% 126% 57% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union South Carolina Municipal Bond Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Y Shares Shares Shares ------------ ------------ ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, 1994* 1994** 1994** - ------------------------------------ ------------ ------------ ------------ Net asset value, beginning of period $9.74 $10.00 $10.00 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.43 0.46 0.41 - ------------------------------------ Net realized and unrealized gain (loss) on investments (1.12) (1.38) (1.38) - ------------------------------------ ------ ------ ------ Total from investment operations (0.69) (0.92) (0.97) - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.43) (0.46) (0.41) - ------------------------------------ ------ ------ ------ Net asset value, end of period $ 8.62 $ 8.62 $ 8.62 - ------------------------------------ ------ ------ ------ Total return+ (7.14%) (9.32%) (9.83%) - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.00%(b) 0.25%(b) 0.87%(b) - ------------------------------------ Net investment income 5.92%(b) 5.57%(b) 4.88%(b) - ------------------------------------ Expense waiver/reimbursement (a) 10.46%(b) 10.46%(b) 10.46%(b) - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $92 $312 $2,456 - ------------------------------------ Portfolio turnover rate 23% 23% 23% - ------------------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from January 3, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above (Note 4). (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Virginia Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Y Shares Shares Shares ------------ --------------- --------------- Year Ended Year Ended Year Ended December 31, December 31, December 31, ------------ --------------- --------------- 1994** 1994 1993* 1994 1993* - ------------------------ ------------ ------ ------ ------ ------ Net asset value, begin- ning of period $ 9.83 $10.19 $10.00 $10.19 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.41 0.47 0.20 0.42 0.17 - ------------------------ Net realized and unrealized gain (loss) on investments (0.98) (1.34) 0.19 (1.34) 0.19 - ------------------------ ------ ------ ------ ------ ------ Total from investment operations (0.57) (0.87) 0.39 (0.92) 0.36 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.41) (0.47) (0.20) (0.42) (0.17) - ------------------------ ------ ------ ------ ------ ------ Net asset value, end of period $ 8.85 $ 8.85 $10.19 $ 8.85 $10.19 - ------------------------ ------ ------ ------ ------ ------ Total return+ (5.82%) (8.60%) 3.89% (9.13%) 3.66% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.28%(b) 0.53% 0.25%(b) 1.12% 0.75%(b) - ------------------------ Net investment income 5.54%(b) 5.11% 4.64%(b) 4.54% 4.25%(b) - ------------------------ Expense waiver/reimbursement (a) 4.61%(b) 4.61% 7.50%(b) 4.61% 7.50%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $344 $1,606 $1,306 $3,817 $2,235 - ------------------------ Portfolio turnover rate 59% 59% 0% 59% 0% - ------------------------
* Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union High Grade Tax Free Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class B Class A Investment Y Shares Investment Shares Shares ------------ -------------------------- ----------------- Year Ended Year Ended Year Ended December 31, December 31, December 31, ------------ -------------------------- ----------------- 1994* 1994 1993 1992** 1994 1993*** - ------------------------ ------------ ------- -------- ------- ------- ------- Net asset value, begin- ning of period $10.93 $11.16 $10.42 $10.00 $11.16 $10.42 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.46 0.52 0.54 0.51 0.46 0.47 - ------------------------ Net realized and unrealized gain (loss) on investments (1.14) (1.37) 0.81 0.42 (1.37) 0.81 - ------------------------ ------ ------ ------ ------ ------ ------ Total from investment operations (0.68) (0.85) 1.35 0.93 (0.91) 1.28 - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.46) (0.52) (0.54) (0.51) (0.46) (0.47) - ------------------------ Distributions to share- holders from net realized gain on in- vestment transactions -- -- (0.07) -- -- (0.07) - ------------------------ ------ ------ ------ ------ ------ ------ Total distributions (0.46) (0.52) (0.61) (0.51) (0.46) (0.54) - ------------------------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.79 $ 9.79 $11.16 $10.42 $ 9.79 $11.16 - ------------------------ ------ ------ ------ ------ ------ ------ Total return+ (6.31%) (7.71%) 13.25% 9.37% (8.24%) 12.41% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.76%(b) 1.01% 0.85% 0.49%(b) 1.58% 1.35%(b) - ------------------------ Net investment income 5.46%(b) 5.04% 4.99% 5.79%(b) 4.47% 4.44%(b) - ------------------------ Expense waiver/reimbursement (a) 0.01%(b) 0.01% 0.22% 0.62%(b) 0.01% 0.22%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $4,318 $57,676 $101,352 $90,738 $32,435 $41,030 - ------------------------ Portfolio turnover rate 53% 53% 14% 7% 53% 14% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from February 21, 1992 (commencement of operations) to December 31, 1992. *** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ INVESTMENT ------------------------ - ------------------------ OBJECTIVES ------------------------ AND POLICIES First Union Single State Municipal Bond Funds seek current income exempt from federal regular income tax and, where applicable, state income taxes, consistent with preservation of capital. The High Grade Tax Free Fund seeks a high level of federally tax free income that is consistent with preservation of capital. In addition, the Florida Municipal Bond Fund intends to qualify as an investment exempt from the Florida state intangibles tax, and the North Carolina Municipal Bond Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. DESCRIPTION OF THE FUNDS Each Single State Municipal Bond Fund seeks current income which is exempt from federal regular income tax and (where applicable) the designated state income tax consistent with preservation of capital. The High Grade Tax Free Fund seeks a high level of federally tax free income that is consistent with preservation of capital. In addition, the Florida Municipal Bond Fund intends to qualify as an investment exempt from the Florida state intangibles tax, and the North Carolina Municipal Bond Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax. As a matter of fundamental investment policy, each Single State Municipal Bond Fund will normally invest its assets so that at least 80% of its annual interest income is, or at least 80% of its net assets are invested in, obligations which provide interest income which is exempt from federal regular income taxes. The High Grade Tax Free Fund, as a matter of fundamental investment policy, will normally invest its assets so that at least 80% of its annual interest income is exempt from federal income taxes (including the alternative minimum tax). The interest retains its tax free status when distributed to the Fund's shareholders. In addition, at least 65% of the value of each Single State Municipal Bond Fund's total assets will be invested in municipal bonds of the particular state after which the Fund is named. At least 65% of the value of the total assets of the High Grade Tax Free Fund will be invested in high grade bonds. High grade bonds mean: bonds insured by a municipal bond insurance company which is rated AAA by Standard and Poor's Ratings Group ("S&P") and/or Aaa by Moody's Investors Service, Inc. ("Moody's"); bonds rated A or better by S&P or Moody's; or, if unrated, of comparable quality as determined by the Adviser. The insurance guarantees the timely payment of principal and interest, but not the value of the municipal bonds or the shares of the Fund. See the section "Municipal Bond Insurance" in this prospectus for further information. To qualify as an investment exempt from the Florida state intangibles tax, the Florida Municipal Bond Fund's portfolio must consist entirely of investments exempt from the Florida state intangibles tax on the last business day of the calendar year. TYPES OF INVESTMENTS Each Single State Municipal Bond Fund seeks to achieve its investment objective by investing principally in municipal obligations, including industrial development bonds, of its designated state. The High Grade Tax Free Fund seeks to achieve its investment policy by investing primarily in a portfolio of high grade bonds. In addition, the Funds may invest in obligations issued by or on behalf of any state, territory, or possession of the United States, including the District of Columbia, or their political subdivisions or agencies and instrumentalities, the interest from which is exempt from federal (regular, if applicable) income tax. It is likely that shareholders who are subject to the alternative minimum tax will be required to include interest from a portion of the municipal securities owned by a Fund in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The municipal bonds in which the Single State Municipal Bond Funds will invest are subject to one or more of the following quality standards: rated Baa or better by Moody's or BBB or better by S&P or, if unrated, determined by the Adviser to be of comparable quality to such ratings; insured by a municipal bond insurance company which is rated Aaa by Moody's or AAA by S&P; guaranteed at the time of purchase by the U.S. government as to the payment of principal and interest; or fully collateralized by an escrow of U.S. government securities. Bonds rated BBB by S&P or Baa by Moody's have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. If any security owned by a Fund loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. If ratings made by Moody's or S&P change because of changes in those organizations or their ratings systems, the Funds will try to use comparable ratings as standards in accordance with the Funds' investment objectives. A description of the rating categories is contained in the Appendix of the Statement of Additional Information for each Fund. Other types of investments include: participation interests in any of the above obligations. (Participation interests may be purchased from financial institutions such as commercial banks, savings and loan associations and insurance companies, and give a Fund an undivided interest in particular municipal securities); variable rate municipal securities. (Variable rate securities offer interest rates which are tied to a money market rate, usually a published interest rate or interest rate index or the 91-day U.S. Treasury bill rate. Many of these securities are subject to prepayment of principal on demand by the Fund, usually in seven days or less); and municipal leases issued by state and local governments or authorities to finance the acquisition of equipment and facilities. The Fund may purchase municipal securities in the form of participation interests which represent undivided proportional interests in lease payments by a governmental or non-profit entity. The lease payments and other rights under the lease provide for and secure the payments on the certificates. Lease obligations may be limited by municipal charter or the nature of the appropriation for the lease. In particular, lease obligations may be subject to periodic appropriation. If the entity does not appropriate funds for future lease payments, the entity cannot be compelled to make such payments. Furthermore, a lease may provide that the certificate trustee cannot accelerate lease obligations upon default. The trustee would only be able to enforce lease payments as they become due. In the event of a default or failure of appropriation, it is unlikely that the trustee would be able to obtain an acceptable substitute source of payment or that the substitute source of payment would generate tax-exempt income. TEMPORARY INVESTMENTS During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, a Fund may temporarily invest in short-term tax- exempt or taxable investments. These temporary investments include: notes issued by or on behalf of municipal or corporate issuers; obligations issued or guaranteed by the U.S. government, its agencies, or instrumentalities; other debt securities; commercial paper; bank certificates of deposit; shares of other investment companies; and repurchase agreements. There are no rating requirements applicable to temporary investments. However, the Adviser will limit temporary investments to those it considers to be of comparable quality to the Fund's primary investments. Although the Funds are permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal regular income tax, where applicable. However, certain temporary investments will generate income which is subject to state taxes. The High Grade Tax Free Fund may also purchase instruments having variable rates of interest. One example is variable amount demand master notes. These notes represent a borrowing arrangement between a commercial paper issuer (borrower) and an institutional lender, such as the Fund, and are payable upon demand. The underlying amount of the loan may vary during the course of the contract, as may the interest on the outstanding amount, depending on a stated short-term interest rate index. MUNICIPAL BONDS Municipal bonds are debt obligations issued by the state or local entities to support a government's general financial needs or special projects, such as housing projects or sewer works. Municipal bonds include industrial development bonds issued by or on behalf of public authorities to provide financing aid to acquire sites or construct or equip facilities for privately or publicly owned corporations. The two principal classifications of municipal bonds are "general obligation" and "revenue" bonds. General obligation bonds are secured by the issuer's pledge of its full faith and credit and taxing power for the payment of principal and interest. Revenue bonds are paid off only with the revenue generated by the project financed by the bond or other specified sources of revenue. For example, in the case of a bridge project, proceeds from the tolls would go directly to retiring the bond issue. Thus, unlike general obligation bonds, revenue bonds do not represent a pledge of credit or create any debt of or charge against the general revenues of a municipality or public authority. The High Grade Tax Free Fund may invest more than 25% of its total assets in industrial development bonds as long as they are not from the same facility or similar types of facilities. RISK FACTORS Bond yields are dependent on several factors including market conditions, the size of an offering, the maturity of the bond, ratings of the bond and the ability of issuers to meet their obligations. There is no limit on the maturity of the bonds purchased by the Funds. Because the prices of bonds fluctuate inversely in relation to the direction of interest rates, the prices of longer term bonds fluctuate more widely in response to market interest rate changes. A Fund's concentration in securities issued by its designated state and that state's political subdivisions provides a greater level of risk than a fund which is diversified across numerous states and municipal entities. An expanded discussion of the risks associated with the purchase of the designated state's municipal bonds is contained in the respective Statements of Additional Information. Although the Funds will not purchase securities rated below BBB by S&P or Baa by Moody's (i.e., junk bonds), the Funds are not required to dispose of securities that have been downgraded subsequent to their purchase. If the municipal obligations held by a Fund (because of adverse economic conditions in a particular state, for example) are downgraded, the Fund's concentration in securities of that state may cause the Fund to be subject to the risks inherent in holding material amounts of low-rated debt securities in its portfolio. MUNICIPAL BOND INSURANCE The High Grade Tax Free Fund will require municipal bond insurance when purchasing municipal securities which would not otherwise meet the Fund's quality standards. The High Grade Tax Free Fund may also require insurance when, in the opinion of the Adviser, such insurance would benefit the Fund (for example, through improvement of portfolio quality or increased liquidity of certain securities). The purpose of municipal bond insurance is to guarantee the timely payment of principal at maturity and interest. Securities in the High Grade Tax Free Fund's portfolio may be insured in one of two ways: (1) by a policy applicable to a specific security, obtained by the issuer of the security or by a third party ("Issuer-Obtained Insurance") or (2) under master insurance policies issued by municipal bond insurers, purchased by the Fund (the "Policies"). If a security's coverage is Issuer-Obtained, then that security does not need to be covered in the Policies. The High Grade Tax Free Fund may purchase Policies from Municipal Bond Investors Assurance Corp., AMBAC Indemnity Corporation, and Financial Guaranty Insurance Company, or any other municipal bond insurer which is rated Aaa by Moody's or AAA by S&P. A more detailed description of these insurers may be found in the High Grade Tax Free Fund's Statement of Additional Information. Annual premiums for these Policies are paid by the Fund and are estimated to range from 0.10% to 0.25% of the value of the municipal securities covered under the Policies, with an average annual premium rate of approximately 0.175%. While the insurance feature reduces financial risk, the cost thereof and the restrictions on investments imposed by the guidelines in the Policies reduce the yield to shareholders. - ------------------------ OTHER INVESTMENT ------------------------ - ------------------------ POLICIES ------------------------ The Funds have adopted the following practices for specific types of investments. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Funds' risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Funds to sell the security in the open market in the case of a default. In such a case, the Funds may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Funds purchase securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause the Funds to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, the Funds may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend their portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, the Funds will not lend any of their assets except portfolio securities up to one-third (in the case of the Single State Municipal Bond Funds) and 15% (in the case of the High Grade Tax Free Fund) of the value of their total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) no Fund will own more than 3% of the total outstanding voting stock of any one investment company, (2) no Fund may invest more than 5% of its total assets in any one investment company and (3) no Fund may invest more than 10% of its total assets in investment companies in general. The Adviser will waive its investment advisory fee on assets invested in securities of other open end investment companies. OPTIONS AND FUTURES The Funds, with the exception of the High Grade Tax Free Fund, may engage in options and futures transactions. Options and futures transactions are intended to enable a Fund to manage market or interest rate risk, and the Funds do not use these transactions for speculation or leverage. The Funds may attempt to hedge all or a portion of their portfolios through the purchase of both put and call options on their portfolio securities and listed put options on financial futures contracts for portfolio securities. The Funds may also write covered call options on their portfolio securities to attempt to increase their current income. The Funds will maintain their positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. The Funds may purchase listed put options on financial futures contracts. These options will be used only to protect portfolio securities against decreases in value resulting from market factors such as an anticipated increase in interest rates. The Funds may write (i.e., sell) covered call and put options. By writing a call option, a Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price. By writing a put option, a Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. The Funds also may write straddles (combinations of covered puts and calls on the same underlying security). The Funds may only write "covered" options. This means that so long as a Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. A Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of the put option, it deposits and maintains with its custodian in a segregated account liquid assets having a value equal to or greater than the exercise price of the option. The principal reason for writing call or put options is to obtain, through a receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Funds receive a premium from writing a call or put option which they retain whether or not the option is exercised. By writing a call option, the Funds might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Funds might become obligated to purchase the underlying securities for more than their current market price upon exercise. A futures contract is a firm commitment by two parties: the seller, who agrees to make delivery of the specific type of instrument called for in the contract ("going short"), and the buyer, who agrees to take delivery of the instrument ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt instruments issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. If a Fund would enter into financial futures contracts directly to hedge its holdings of fixed income securities, it would enter into contracts to deliver securities at an undetermined price (i.e., "go short") to protect itself against the possibility that the prices of its fixed income securities may decline during the Fund's anticipated holding period. A Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. The Funds may also enter into financial futures contracts and write options on such contracts. The Funds intend to enter into such contracts and related options for hedging purposes. The Funds will enter into futures on securities or index-based futures contracts in order to hedge against changes in interest rates or securities prices. A futures contract on securities is an agreement to buy or sell securities during a designated month at whatever price exists at that time. A futures contract on a securities index does not involve the actual delivery of securities, but merely requires the payment of a cash settlement based on changes in the securities index. The Funds do not make payment or deliver securities upon entering into a futures contract. Instead, they put down a margin deposit, which is adjusted to reflect changes in the value of the contract and which remains in effect until the contract is terminated. The Funds may sell or purchase other financial futures contracts. When a futures contract is sold by a Fund, the profit on the contract will tend to rise when the value of the underlying securities declines and to fall when the value of such securities increases. Thus, the Funds sell futures contracts in order to offset a possible decline in the profit on their securities. If a futures contract is purchased by a Fund, the value of the contract will tend to rise when the value of the underlying securities increases and to fall when the value of such securities declines. The Funds may enter into closing purchase and sale transactions in order to terminate a futures contract and may buy or sell put and call options for the purpose of closing out their options positions. The Funds' ability to enter into closing transactions depends on the development and maintenance of a liquid secondary market. There is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. As a result, there can be no assurance that the Funds will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Funds are not able to enter into an offsetting transaction, the Funds will continue to be required to maintain the margin deposits on the contract and to complete the contract according to its terms, in which case the Funds would continue to bear market risk on the transaction. RISK CHARACTERISTICS OF OPTIONS AND FUTURES Although options and futures transactions are intended to enable the Funds to manage market or interest rate risks, these investment devices can be highly volatile, and the Funds' use of them can result in poorer performance (i.e., the Funds' return may be reduced). The Funds' attempt to use such investment devices for hedging purposes may not be successful. Successful futures strategies require the ability to predict future movements in securities prices, interest rates and other economic factors. When the Funds use financial futures contracts and options on financial futures contracts as hedging devices, there is a risk that the prices of the securities subject to the financial futures contracts and options on financial futures contracts may not correlate perfectly with the prices of the securities in the Funds' portfolios. This may cause the financial futures contract and any related options to react to market changes differently than the portfolio securities. In addition, the Adviser could be incorrect in its expectations and forecasts about the direction or extent of market factors, such as interest rates, securities price movements, and other economic factors. Even if the Adviser correctly predicts interest rate movements, a hedge could be unsuccessful if changes in the value of a Fund's futures position did not correspond to changes in the value of its investments. In these events, the Funds may lose money on the financial futures contracts or the options on financial futures contracts. It is not certain that a secondary market for positions in financial futures contracts or for options on financial futures contracts will exist at all times. Although the Adviser will consider liquidity before entering into financial futures contracts or options on financial futures contracts transactions, there is no assurance that a liquid secondary market on an exchange will exist for any particular financial futures contract or option on a financial futures contract at any particular time. The Funds' ability to establish and close out financial futures contracts and options on financial futures contract positions depends on this secondary market. If a Fund is unable to close out its position due to disruptions in the market or lack of liquidity, the Fund may lose money on the futures contract or option, and the losses to the Fund could be significant. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money or pledge securities, except under certain circumstances each Fund may borrow up to one-third of the value of its total assets and pledge assets to secure such borrowings. SELLING SHORT The High Grade Tax Free Fund will not make short sales of securities, except in certain circumstances. RESTRICTED AND ILLIQUID SECURITIES The High Grade Tax Free Fund will not invest more than 10% of its total assets in securities subject to restrictions on resale under federal securities laws. The High Grade Tax Free Fund will not invest more than 15% of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities not determined by the Trustees to be liquid. NON-DIVERSIFICATION Each of the Single State Municipal Bond Funds is a non-diversified portfolio of an investment company and as such, there is no limit on the percentage of assets which can be invested in any single issuer. An investment in a Fund, therefore, will entail greater risk than would exist in a diversified investment company because the higher percentage of investments among fewer issuers may result in greater fluctuation in the total market value of the Fund's portfolio. Each of the Single State Municipal Bond Funds intends to comply with Subchapter M of the Internal Revenue Code which requires that at the end of each quarter of each taxable year, with regard to at least 50% of the Fund's total assets, no more than 5% of the total assets may be invested in the securities of a single issuer and that with respect to the remainder of the Fund's total assets, no more than 25% of its total assets are invested in the securities of a single issuer. The following investment limitations may be changed by the Trustees without shareholder approval: RESTRICTED AND ILLIQUID SECURITIES The Single State Municipal Bond Funds may not invest more than 15% of their net assets in securities which are subject to restrictions on resale under federal securities law. Certain restricted securities which the Trustees deem to be liquid will be excluded from this limitation. The Single State Municipal Bond Funds will limit investments in illiquid securities, including certain restricted securities or municipal leases not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice, to 15% of their net assets. NEW ISSUERS The Single State Municipal Bond Funds will not invest more than 5% of the value of their total assets in securities of issuers (or guarantors, where applicable) which have records of less than three years of continuous operations, including the operation of any predecessor. WARRANTS The High Grade Tax Free Fund may not invest more than 5% of its net assets in warrants. No more than 2% of this 5% may be in warrants which are not listed on the New York or American Stock Exchanges. - ------------------------ SHAREHOLDER GUIDE ------------------------ - ------------------------ ------------------------ SHARE PRICE CALCULATION In the case of no-load Funds, the net asset value, the market price and the offering price of Shares are all the same. Purchases, redemptions, and exchanges are made at net asset value. The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares and Class B Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares) for each class of shares. The net asset value for each Fund will fluctuate for all three classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return, yield, or tax equivalent yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Y Shares. It is generally reported using total return, yield, and tax equivalent yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yields of Y Shares are calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. Tax equivalent yield is calculated like the yield described above, except that for any given tax bracket, net investment income will be calculated as the sum of any taxable income and the tax exempt income divided by the difference between 1 and the federal tax rates for taxpayers in that tax bracket. The yield and tax equivalent yield do not necessarily reflect income actually earned by Y Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return, yield, and tax equivalent yield will be calculated separately for Y Shares, Class A Shares, and Class B Shares of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee and Class B Shares are subject to a Rule 12b-1 fee and a shareholder services fee, the yield and tax equivalent yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares are subject to similar non-recurring charges, such as the contingent deferred sales charge ("CDSC"), which, if excluded, would increase the total return for Class B Shares. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. - ------------------------ HOW TO BUY ------------------------ - ------------------------ SHARES ------------------------ Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There are no sales charges imposed on Y Shares of the Funds. However, there is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Capital Management Group of First Union at 1- 800-326-2584. Subsequent investments may be in any amounts. BY TELEPHONE You may purchase Y Shares by telephone from the Capital Management Group of First Union at 1-800-326-2584. (Texas residents should directly contact the Mutual Funds Group of First Union Brokerage Services, Inc. at 1-800-326-3241.) Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. Purchase orders must be received by 4:00 p.m. (Eastern time). Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT - ------------------------ FROM ONE ------------------------ - ------------------------ FIRST UNION ------------------------ FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call First Union at 1-800-326-2584 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another, which may produce a gain or loss for tax purposes. You may exchange Y Shares of one First Union Fund for Y Shares of any other First Union Fund by calling toll free 1-800-326-2584 or by writing to First Union. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and, shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. - ------------------------ HOW TO ------------------------ - ------------------------ REDEEM SHARES ------------------------ Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any fees. You may redeem Shares in person or by telephoning First Union at 1-800-326-2584 or by written request to First Union. There is no redemption fee charged. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. - ------------------------ MANAGEMENT ------------------------ - ------------------------ OF FIRST ------------------------ UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. Robert S. Drye is a Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1968. Since 1989, Mr. Drye has served as a portfolio manager for several of the First Union Funds and for certain common trust funds. Prior to 1989, Mr. Drye worked as a marketing specialist with First Union Brokerage Services, Inc. Mr. Drye has managed the South Carolina Municipal Bond Fund since its inception in January 1994. In addition, Mr. Drye has been the portfolio manager for the Florida Municipal Bond Fund since its inception in July 1993. Mr. Drye has also managed the High Grade Tax Free Fund since its inception in February, 1992. Richard K. Marrone is a Vice President of First Union National Bank of North Carolina, N.A. Mr. Marrone joined First Union in May 1993 with eleven years of experience managing fixed income assets at Woodbridge Capital Management, a subsidiary of Comerica Bank, N.A. Mr. Marrone is responsible for the portfolio management of several First Union Funds and certain common trust funds. Mr. Marrone has served as portfolio manager of the North Carolina Municipal Bond Fund since May 1993, and portfolio manager of the Georgia Municipal Bond Fund since its inception in July 1993. Charles E. Jeanne joined First Union National Bank of North Carolina, N.A., in July 1993. Prior to joining First Union, Mr. Jeanne served as a trader/portfolio manager for First American Bank where he was responsible for individual accounts and common trust funds. Mr. Jeanne has been the portfolio manager for the Virginia Municipal Bond Fund since its inception in July 1993. FUND ADMINISTRATION Federated Securities Corp., Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. - ------------------------ FEES AND EXPENSES ------------------------ - ------------------------ ------------------------ Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to .50 of 1% of each of the Tax-Free Fund's average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust ------------------- ------------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND Y SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares and Class B Shares. In addition, the Funds' expenses under the Shareholder Services Plan are incurred solely by the Class B Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal, and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. - ------------------------ SHAREHOLDER --------------------- - ------------------------ RIGHTS AND --------------------- PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 7, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 133,591.799 Shares (67.297%) of the Florida Municipal Bond Fund-Y Shares; approximately 132,561.656 Shares (99.934%) of the Georgia Municipal Bond Fund-Y Shares; approximately 13,856.813 Shares (56.260%) of the South Carolina Municipal Bond Fund-Y Shares; approximately 33,347.986 Shares (73.387%) of the Virginia Municipal Bond Fund-Y Shares; and 398,873.093 Shares (91.900%) of the High Grade Tax Free Fund-Y Shares; and First Union National Bank-Capital Management Group, for the exclusive benefit of Lawrence and Jean Farry, Charlotte, North Carolina, owned approximately 6,314.849 Shares (25.639%) of the South Carolina Municipal Bond Fund-Y Shares; and, for the exclusive benefit of Thomas B. Carr and Louise B. Carr of Wylie, South Carolina, owned approximately 16,326.787 Shares (44.738%) of the South Carolina Municipal Bond Fund-Class A Investment Shares; and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. - ------------------------ DISTRIBUTIONS ------------------------ - ------------------------ AND TAXES ------------------------ Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared daily and paid monthly. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or First Union in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. - ------------------------ TAX INFORMATION ------------------------ - ------------------------ ------------------------ Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Shareholders of the Funds are not required to pay the federal regular income tax on any dividends and other distributions received from a Fund that represent net interest on tax-exempt municipal bonds. However, under the Tax Reform Act of 1986, dividends representing net interest earned on some municipal bonds may be included in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The alternative minimum tax, up to 28% of alternative minimum taxable income for individuals and 20% for corporations, applies when it exceeds the regular tax for the taxable year. Alternative minimum taxable income is equal to the adjusted income of the taxpayer increased by certain "tax preference" items not included in regular taxable income and reduced by only a portion of the deductions allowed in the calculation of the regular tax. The Tax Reform Act of 1986 treats interest on certain "private activity" bonds issued after August 7, 1986, as a tax preference item. Unlike traditional governmental purpose municipal bonds, which finance roads, schools, libraries, prisons, and other public facilities, private activity bonds provide benefits to private parties. The Funds may purchase all types of municipal bonds, including "private activity" bonds. Thus, should a Fund purchase any such bonds, a portion of the Fund's dividends may be treated as a tax preference item. In addition, in the case of a corporate shareholder, dividends of a Fund which represent interest on municipal bonds may be subject to the 20% corporate alternative minimum tax because the dividends are included in a corporation's "adjusted current earnings." The corporate alternative minimum tax treats 75% of the excess of a taxpayer's pre-tax "adjusted current earnings" over the taxpayer's alternative minimum taxable income as a tax preference item. "Adjusted current earnings" is based upon the concept of a corporation's "earnings and profits." Since "earnings and profits" generally includes the full amount of any Fund dividend, and alternative minimum taxable income does not include the portion of the Fund's dividend attributable to municipal bonds which are not private activity bonds, the difference will be included in the calculation of the corporation's alternative minimum tax. Shareholders are urged to consult their own tax advisers to determine whether they are subject to alternative minimum tax or the corporate alternative minimum tax and, if so, the tax treatment of dividends paid by the Funds. Dividends of a Fund representing net interest income earned on some temporary investments, income earned on options transactions, and any realized net short- term gains are taxed as ordinary income. Distributions representing net long- term capital gains realized by the Funds, if any, will be taxable as long-term capital gains regardless of the length of time shareholders have held their Shares. These tax consequences apply whether dividends are received in cash or as additional Shares. Information on the tax status of dividends and distributions is provided annually. Set forth below are brief descriptions of the personal income tax status of an investment in each of the Single State Municipal Bond Funds under, respectively, Florida, Georgia, North Carolina, South Carolina, and Virginia tax laws currently in effect. Income from a Fund is not necessarily free from state income taxes in states other than its designated state. State laws differ on this issue, and shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local laws. A statement setting forth the state income tax status of all distributions made during each calendar year will be sent to shareholders annually. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE FLORIDA MUNICIPAL BOND FUND Florida does not currently impose an income tax on individuals. Thus, individual shareholders of the Florida Municipal Bond Fund will not be subject to any Florida state income tax on distributions received from the Florida Municipal Bond Fund. However, certain distributions will be taxable to corporate shareholders which are subject to Florida corporate income tax. Florida currently imposes an intangibles tax at the annual rate of 0.20% on certain securities and other intangible assets owned by Florida residents. Certain types of tax exempt securities of Florida issuers, U.S. government securities and tax exempt securities issued by certain U.S. territories and possessions are exempt from this intangibles tax. Shares of the Florida Municipal Bond Fund will also be exempt from the Florida intangibles tax if the portfolio consists exclusively of securities exempt from the intangibles tax on the last business day of the calendar year. If the portfolio consists of any assets which are not so exempt on the last business day of the calendar year, however, only the portion of the Shares of the Florida Municipal Bond Fund which relate to securities issued by the United States and its possessions and territories will be exempt from the Florida intangibles tax, and the remaining portion of such Shares will be fully subject to the intangibles tax, even if they partly relate to Florida tax exempt securities. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE GEORGIA MUNICIPAL BOND FUND Under existing Georgia law, shareholders of the Georgia Municipal Bond Fund will not be subject to individual or corporate Georgia income taxes on distributions from the Georgia Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest-bearing obligations issued by or on behalf of the State of Georgia or its political subdivisions, or (2) interest on obligations of the United States or of any other issuer whose obligations are exempt from state income taxes under federal law. Distributions, if any, derived from capital gains or other sources generally will be taxable for Georgia income tax purposes to shareholders of the Georgia Municipal Bond Fund who are subject to the Georgia income tax. For purposes of the Georgia intangibles tax, Shares of the Georgia Municipal Bond Fund likely are taxable (at the rate of 10 cents per $1,000 in value of the Shares held on January 1 of each year) to shareholders who are otherwise subject to such tax. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE NORTH CAROLINA MUNICIPAL BOND FUND Under existing North Carolina law, shareholders of the North Carolina Municipal Bond Fund will not be subject to individual or corporate North Carolina income taxes on distributions from the North Carolina Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest on obligations issued by North Carolina and political subdivisions thereof, or (2) interest on obligations of the United States or its territories or possessions. Distributions, if any, derived from capital gains or other sources generally will be taxable for North Carolina income tax purposes to shareholders of the North Carolina Municipal Bond Fund who are subject to the North Carolina income tax. North Carolina currently imposes an intangibles tax (at the rate of 25 cents per $100 in value of the shares held on December 31 of each year) on all shares of stock, including mutual funds. However, shareholders of the North Carolina Municipal Bond Fund may exclude from share value that proportion of the total share value which is attributable to direct obligations of the State of North Carolina, its subdivisions, and the United States held in the North Carolina Municipal Bond Fund as of December 31 of the taxable year. The North Carolina Municipal Bond Fund will annually furnish to its shareholders a statement supporting the proper allocation. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE SOUTH CAROLINA MUNICIPAL BOND FUND Under existing South Carolina law, shareholders of the South Carolina Municipal Bond Fund will not be subject to individual or corporate South Carolina income taxes on South Carolina Municipal Bond Fund distributions to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest on obligations of the State of South Carolina, or any of its political subdivisions, (2) interest on obligations of the United States, or (3) interest on obligations of any agency or instrumentality of the United States that is prohibited by federal law from being taxed by a state or any political subdivision of a state. Distributions, if any, derived from capital gains or other sources, generally will be taxable for South Carolina income tax purposes to shareholders of South Carolina Municipal Bond Fund who are subject to South Carolina income tax. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE VIRGINIA MUNICIPAL BOND FUND Under existing Virginia law, shareholders of the Virginia Municipal Bond Fund will not be subject to individual or corporate Virginia income taxes on distributions received from the Virginia Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to interest earned on (1) obligations issued by or on behalf of the Commonwealth of Virginia or any political subdivision thereof, or (2) obligations issued by a territory or possession of the United States or any subdivision thereof which federal law exempts from state income taxes. Distributions, if any, derived from capital gains or other sources generally will be taxable for Virginia income tax purposes to shareholders of the Virginia Municipal Bond Fund who are subject to Virginia income tax. - ------------------------ OTHER CLASSES ------------------------ - ------------------------ OF SHARES ------------------------ First Union Tax-Free Funds offer three classes of shares: Y Shares for institutional investors and Class A Shares and Class B Shares for individuals and other customers of First Union. Class A Shares and Class B Shares are sold to customers of First Union and others at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B Shares). Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. In addition, no front-end sales charges are imposed on Class A shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non-qualified employee benefit and savings plans which make shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker-dealers or other financial intermediaries whose employee benefit plan clients purchase shares under the foregoing front-end sales charge exemption in an amount up to .50 of 1% of the net asset value of shares purchased. These payments are subject to reclaim in the event shares are redeemed within 12 months after purchase. Class A Shares and Class B Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of 0.25 of 1% for Class A Shares and 0.75 of 1% for Class B Shares of each Fund's average daily net asset value. In addition, Class B Shares pay a shareholder services fee of 0.25 of 1% of Class B Shares' average daily net assets. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares and Class B Shares will be less than those payable to Y Shares by the difference between Class Expenses, distribution, and shareholder services expenses borne by the shares of each respective class. - --------------------- SHAREHOLDER REPORTS --------------------- - --------------------- --------------------- Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (same surname, same address). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either contact the Capital Management Group of First Union at 1-800-326-2584, or write the Trust. - ------------------------ ADDRESSES ------------------------ - ------------------------ ------------------------ - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266- 8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- [This Page Intentionally Left Blank] Federated Securities Corp., Distributor 535670 (10/pkg.) G00850-04 (2/95) PROSPECTUS FIRST UNION TAX-FREE FUNDS CLASS A AND B INVESTMENT SHARES FEBRUARY 28, 1995 FIRST UNION - --------------------------- TAX-FREE --------------------------- - --------------------------- FUNDS --------------------------- Portfolios of First Union Funds CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES - ------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes one diversified and five non-diversified Tax-Free Funds, three diversified Growth and Income Funds, three diversified Income Funds, two diversified Growth Funds, and three diversified Money Market Funds. They are: Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. This prospectus provides you with information specific to the Class A Investment Shares ("Class A Shares") and Class B Investment Shares ("Class B Shares") (collectively referred to as "Investment Shares") of First Union Tax- Free Funds. It concisely describes the information which you should know before investing in Class A Shares or Class B Shares of any of the First Union Tax-Free Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Tax-Free Fund in its Statement of Additional Information dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-3241. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. For a description of the nature and limitations of municipal bond insurance, see "Municipal Bond Insurance," page 17. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. - ------------------------ TABLE OF ------------------------ - ------------------------ CONTENTS ------------------------ Summary 2 How to Redeem Shares 27 - ------------------------------------- ------------------------------------- Summary of Fund Expenses 4 Additional Shareholder Services 27 - ------------------------------------- ------------------------------------- Financial Highlights 9 Management of First Union Funds 28 - ------------------------------------- ------------------------------------- Investment Objectives and Policies 15 Fees and Expenses 30 - ------------------------------------- ------------------------------------- Other Investment Policies 18 Shareholder Rights and Privileges 31 - ------------------------------------- ------------------------------------- Shareholder Guide 22 Distributions and Taxes 32 - ------------------------------------- ------------------------------------- How to Buy Shares 23 Tax Information 32 - ------------------------------------- ------------------------------------- How to Convert Your Investment from Other Classes of Shares 35 One First Union Fund to Another ------------------------------------- First Union Fund 26 - ------------------------------------- Shareholder Reports 35 ------------------------------------- Addresses 36 ------------------------------------- - ------------------------ SUMMARY ------------------------ - ------------------------ ------------------------ DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Tax-Free Fund currently offers three classes of shares: Class A Shares, Class B Shares, and Y Shares. Class A Shares and Class B Shares are sold to individuals and other customers of First Union (the "Adviser"), and are sold at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B Shares). Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates to both classes of Investment Shares ("Shares") of the First Union Tax-Free Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following six Tax- Free Funds: . First Union Florida Municipal Bond Portfolio ("Florida Municipal Bond Fund")--seeks current income exempt from federal regular income tax consistent with preservation of capital. In addition, the Fund intends to qualify as an investment exempt from the Florida state intangibles tax; . First Union Georgia Municipal Bond Portfolio ("Georgia Municipal Bond Fund")--seeks current income exempt from federal regular income tax and Georgia state income tax, consistent with preservation of capital; . First Union North Carolina Municipal Bond Portfolio ("North Carolina Municipal Bond Fund")--seeks current income exempt from federal regular income tax and North Carolina state income tax, consistent with preservation of capital. In addition, the Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax; . First Union South Carolina Municipal Bond Portfolio ("South Carolina Municipal Bond Fund")--seeks current income exempt from federal regular income tax and South Carolina state income tax; . First Union Virginia Municipal Bond Portfolio ("Virginia Municipal Bond Fund")--seeks current income exempt from federal regular income tax and Virginia state income tax, consistent with preservation of capital; and . First Union High Grade Tax Free Portfolio ("High Grade Tax Free Fund")-- seeks to provide a high level of federally tax free income that is consistent with preservation of capital. The First Union Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Portfolios may be referred to herein as the "Single State Municipal Bond Funds." INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Class A and Class B Shares of any of the Tax-Free Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION TAX FREE FUNDS CLASS A SHARES
North South Florida Georgia Carolina Carolina Virginia High Grade Municipal Municipal Municipal Municipal Municipal Tax Free Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund Fund Class A Shares-- --------- --------- --------- --------- --------- ---------- Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price).... 4.75% 4.75% 4.75% 4.75% 4.75% 4.75% Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)..................... None None None None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable).... None None None None None None Redemption Fee (as a percentage of amount redeemed, if applicable)........ None None None None None None Exchange Fee............................ None None None None None None Annual Class A Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1)....... 0.01% 0.00% 0.19% 0.00% 0.00% 0.50% 12b-1 Fees (2).......................... 0.25% 0.25% 0.25% 0.25% 0.25% 0.25% Total Other Expenses (after waiver and reimbursement) (3)................. 0.48% 0.45% 0.44% 0.40% 0.50% 0.33% Total Class A Shares Operating Expenses (4)....................... 0.74% 0.70% 0.88% 0.65% 0.75% 1.08%
(1) The management fees, except for the High Grade Tax Free Fund, have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee for each Fund is 0.50%. (2) The Class A Shares can pay up to 0.75 of 1% of Class A Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit the Class A Shares' 12b-1 payments to 0.25 of 1% of Class A Shares' average daily net assets. (3) Total Other Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds are expected to be 0.65%, 2.06%, 0.50%, 5.82% and 3.04%, respectively, absent the voluntary waivers by the administrator and reimbursement of other operating expenses by the Adviser for Georgia, South Carolina and Virginia Municipal Bond Funds. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds' and High Grade Tax Free Fund's Total Class A Shares Annual Operating Expenses were 0.64%, 0.53%, 0.79%, 0.25%, 0.53%, and 1.01%, respectively, for the year ended December 31, 1994. Total Class A Shares Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds and High Grade Tax Free Fund absent the voluntary waiver of the management fee and reimbursement of other operating expenses of Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds by the Adviser and the voluntary waiver of the administrative fee, except for High Grade Tax Free Fund, by the administrator were 1.40%, 3.61%, 1.18%, 10.71%, 5.14% and 1.02%, respectively, for the year ended December 31, 1994. The Annual Class A Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class A Shares expected Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds would be 1.40%, 2.81%, 1.25%, 6.57%, and 3.79%, respectively, absent the voluntary waivers and reimbursements described above in notes 1 and 2. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION TAX-FREE FUNDS CLASS A SHARES (Continued) EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return, (2) redemption at the end of each time period; and (3) payment of the maximum sales load. The Funds charge no redemption fees for Class A Shares. Florida Municipal Bond Fund................. $55 $70 $ 87 $135 Georgia Municipal Bond Fund................. $54 $69 $ 85 $130 North Carolina Municipal Bond Fund.......... $56 $74 $ 94 $151 South Carolina Municipal Bond Fund.......... $54 $67 $ 82 $125 Virginia Municipal Bond Fund................ $55 $70 $ 87 $136 High Grade Tax Free Fund.................... $58 $80 $104 $173 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class A Shares of the Funds. The Funds also offer two additional classes of shares called Y Shares and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares and Class B Shares are subject to certain of the same expenses as Class A Shares. However, Y Shares bear no sales load or 12b-1 fee. Class B Shares are subject to a 12b- 1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales load. See "Other Classes of Shares." - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES --------------------------
FIRST UNION TAX-FREE FUNDS CLASS B SHARES Florida Municipal Georgia Municipal North Carolina Bond Fund Bond Fund Municipal Bond Fund ----------------------------- ----------------------------- ----------------------------- Class B Shares-- Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................. None None None Contingent Deferred 5% during the first year, 5% during the first year, 5% during the first year, Sales Charge (as a 4% during the second year, 4% during the second year, 4% during the second year, percentage of original 3% during the third year, 3% during the third year, 3% during the third year, purchase price or 3% during the fourth year, 3% during the fourth year, 3% during the fourth year, redemption proceeds, as 2% during the fifth year, 2% during the fifth year, 2% during the fifth year, applicable) (1)........ 1% during the sixth year, 1% during the sixth year, 1% during the sixth year, 1% during the seventh year, 1% during the seventh year 1% during the seventh year, and 0% after the seventh year and 0% after the seventh year and 0% after the seventh year Redemption Fee (as a percentage of amount redeemed, if applicable)............ None None None Exchange Fee............ None None None Annual Class B Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (2)............ 0.01% 0.00% 0.19% 12b-1 Fees.............. 0.75% 0.75% 0.75% Total Other Expenses (after waiver and reimbursement) (3)..... 0.73% 0.70% 0.69% Shareholder Service Fee (4)................ 0.25% 0.25% 0.25% Total Class B Shares Operating Expenses (5)..... 1.49% 1.45% 1.63%
- -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION TAX-FREE FUNDS CLASS B SHARES South Carolina Virginia Municipal High Grade Municipal Bond Fund Bond Fund Tax Free Fund ----------------------------- ----------------------------- ----------------------------- Class B Shares-- Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................. None None None Contingent Deferred 5% during the first year, 5% during the first year, 5% during the first year, Sales Charge (as a 4% during the second year, 4% during the second year, 4% during the second year, percentage of original 3% during the third year, 3% during the third year, 3% during the third year, purchase price or 3% during the fourth year, 3% during the fourth year, 3% during the fourth year, redemption proceeds, as 2% during the fifth year, 2% during the fifth year, 2% during the fifth year, applicable) (1)........ 1% during the sixth year, 1% during the sixth year, 1% during the sixth year, 1% during the seventh year, 1% during the seventh year, 1% during the seventh year, and 0% after the seventh year and 0% after the seventh year and 0% after the seventh year Redemption Fee (as a percentage of amount redeemed, if applicable)............ None None None Exchange Fee............ None None None Annual Class B Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (2)............ 0.00% 0.00% 0.50% 12b-1 Fees.............. 0.75% 0.75% 0.75% Total Other Expenses (after waiver and reimbursement) (3)..... 0.65% 0.75% 0.58% Shareholder Service Fee (4)................ 0.25% 0.25% 0.25% Total Class B Shares Operating Expenses (5)..... 1.40% 1.50% 1.83%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than seven years prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per share. (2) The management fees, except for High Grade Tax Free Fund, have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee for each Fund is 0.50%. (3) Total Other Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds are expected to be 0.90%, 2.31%, 0.75%, 6.07% and 3.29%, respectively, absent the voluntary waivers by the administrator and reimbursement of other operating expenses by the Adviser for Georgia, South Carolina and Virginia Municipal Bond Funds. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Funds began accruing Shareholder Service Fees in September, 1994 at the maximum rate of 0.25%. Shareholder Service Fees for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds and High Grade Tax Free Fund amounted to 0.08%, 0.09%, 0.08%, 0.12%, 0.09%, and 0.07%, respectively, for the fiscal year ended December 31, 1994. (5) Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds' and High Grade Tax Free Fund's Total Class B Shares Annual Operating Expenses were 1.22%, 1.13%, 1.37%, 0.87%, 1.12%, and 1.58%, respectively, for the year ended December 31, 1994. Total Class B Shares Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds and High Grade Tax Free Fund absent the voluntary waiver of the management fee and reimbursement of other operating expenses of Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds by the Adviser and the voluntary waiver of the administrative fee, except for High Grade Tax Free Fund, by the administrator were 1.98%, 4.21%, 1.76%, 11.33%, 5.73% and 1.59%, respectively, for the year ended December 31, 1994. The Annual Class B Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class B Shares expected Operating Expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds would be 2.15%, 3.56%, 2.00%, 7.32%, and 4.54%, respectively, absent the voluntary waivers and reimbursements described above in notes 2 and 3. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION TAX-FREE FUNDS CLASS B SHARES Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc. EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. Florida Municipal Bond Fund................. $67 $80 $105 $178 Georgia Municipal Bond Fund................. $67 $79 $103 $174 North Carolina Municipal Bond Fund.......... $68 $85 $112 $193 South Carolina Municipal Bond Fund.......... $66 $78 $100 $168 Virginia Municipal Bond Fund................ $67 $81 $106 $179 High Grade Tax Free Fund.................... $70 $91 $122 $215 You would pay the following expenses on the same investment, assuming no redemptions: Florida Municipal Bond Fund................. $15 $47 $ 81 $178 Georgia Municipal Bond Fund................. $15 $46 $ 79 $174 North Carolina Municipal Bond Fund.......... $17 $51 $ 89 $193 South Carolina Municipal Bond Fund.......... $14 $44 $ 77 $168 Virginia Municipal Bond Fund................ $15 $47 $ 82 $179 High Grade Tax Free Fund.................... $19 $58 $ 99 $215 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class B Shares of the Funds. The Funds also offer two additional classes of shares called Y Shares and Class A Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares and Class A Shares are subject to certain of the same expenses as Class B Shares. However, Y Shares bear no sales load or 12b-1 fee, and Class A Shares are subject to a 12b-1 fee of 0.25 of 1%, bear a maximum front-end sales load of 4.75%, and bear no contingent deferred sales charge. See "Other Classes of Shares." - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Florida Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Shares Shares Y Shares --------------- ----------------- ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, --------------- ----------------- ------------ 1994 1993* 1994 1993** 1994*** - ------------------------ ------ ------ ------- ------- ------------ Net asset value, begin- ning of period $10.34 $10.00 $10.34 $10.00 $ 9.99 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.49 0.22 0.43 0.20 0.42 - ------------------------ Net realized and unrealized gain (loss) on investments (1.42) 0.34 (1.42) 0.34 (1.07) - ------------------------ ------ ------ ------ ------ ------ Total from investment operations (0.93) 0.56 (0.99) 0.54 (0.65) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.49) (0.22) (0.43) (0.20) (0.42) - ------------------------ ------ ------ ------ ------ ------ Net asset value, end of period $ 8.92 $10.34 $ 8.92 $10.34 $ 8.92 - ------------------------ ------ ------ ------ ------ ------ Total return+ (9.14%) 5.63% (9.66%) 5.40% (6.54%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.64% 0.25%(b) 1.22% 0.75%(b) 0.39%(b) - ------------------------ Net investment income 5.19% 4.92%(b) 4.61% 4.46%(b) 5.54%(b) - ------------------------ Expense waiver/reimbursement (a) 0.76% 1.58%(b) 0.76% 1.58%(b) 0.76%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $8,689 $8,110 $24,756 $18,383 $1,764 - ------------------------ Portfolio turnover rate 72% 3% 72% 3% 72% - ------------------------
* Reflects operations for the period from July 6, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. *** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Georgia Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995 on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Shares Shares Y Shares ---------------- ----------------- ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, ---------------- ----------------- ------------ 1994 1993** 1994 1993** 1994* - ------------------------ ------ ------- -------- ------- ------------ Net asset value, begin- ning of period $10.19 $10.00 $10.19 $10.00 $ 9.83 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.48 0.201 0.43 0.179 0.42 - ------------------------ Net realized and unrealized gain (loss) on investments (1.45) 0.193 (1.45) 0.193 (1.09) - ------------------------ ------ ------- ------ ------- ------ Total from investment operations (0.97) 0.394 (1.02) 0.372 (0.67) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.48) (0.201) (0.43) (0.179) (0.42) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions -- (0.003) -- (0.003) -- - ------------------------ ------ ------- ------ ------- ------ Total distributions (0.48) (0.204) (0.43) (0.182) (0.42) - ------------------------ ------ ------- ------ ------- ------ Net asset value, end of period $ 8.74 $10.19 $ 8.74 $10.19 $ 8.74 - ------------------------ ------ ------- ------ ------- ------ Total return+ (9.64%) 3.96% (10.15%) 3.74% (6.87%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.53% 0.25%(b) 1.13% 0.75%(b) 0.31%(b) - ------------------------ Net investment income 5.26% 4.71%(b) 4.66% 4.15%(b) 5.68%(b) - ------------------------ Expense waiver/reimbursement (a) 3.08% 6.57%(b) 3.08% 6.57%(b) 3.08%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $1,387 $817 $6,912 $3,692 $284 - ------------------------ Portfolio turnover rate 147% 15% 147% 15% 147% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union North Carolina Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Shares Shares Y Shares ----------------- ----------------- ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, ----------------- ----------------- ------------ 1994 1993** 1994 1993** 1994* - ------------------------ -------- ------- -------- ------- ------------ Net asset value, begin- ning of period $10.61 $10.00 $10.61 $10.00 $10.31 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.49 0.46 0.44 0.42 0.43 - ------------------------ Net realized and unrealized gain (loss) on investments (1.45) 0.64 (1.45) 0.64 (1.15) - ------------------------ ------- ------ ------- ------ ------ Total from investment operations (0.96) 1.10 (1.01) 1.06 (0.72) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.49) (0.46) (0.44) (0.42) (0.43) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions -- (0.03) -- (0.03) -- - ------------------------ ------- ------ ------- ------ ------ Total distributions (0.49) (0.49) (0.44) (0.45) (0.43) - ------------------------ Net asset value, end of period $ 9.16 $10.61 $ 9.16 $10.61 $ 9.16 - ------------------------ ------- ------ ------- ------ ------ Total return+ (9.12%) 11.28% (9.64%) 10.80% (7.03%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.79% 0.32%(b) 1.37% 0.79%(b) 0.59%(b) - ------------------------ Net investment income 5.11% 4.91%(b) 4.53% 4.47%(b) 5.58%(b) - ------------------------ Expense waiver/reimbursement (a) 0.39% 0.93%(b) 0.39% 0.95%(b) 0.39%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $7,979 $12,739 $44,616 $45,168 $642 - ------------------------ Portfolio turnover rate 126% 57% 126% 57% 126% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union South Carolina Municipal Bond Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Shares Shares Y Shares ------------ ------------ ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, 1994* 1994* 1994** - ------------------------------------ ------------ ------------ ------------ Net asset value, beginning of period $10.00 $10.00 $ 9.74 - ------------------------------------ Income from investment operations - ------------------------------------ Net investment income 0.46 0.41 0.43 - ------------------------------------ Net realized and unrealized gain (loss) on investments (1.38) (1.38) (1.12) - ------------------------------------ ------ ------ ------- Total from investment operations (0.92) (0.97) (0.69) - ------------------------------------ Less distributions - ------------------------------------ Dividends to shareholders from net investment income (0.46) (0.41) (0.43) - ------------------------------------ ------ ------ ------- Net asset value, end of period $ 8.62 $ 8.62 $ 8.62 - ------------------------------------ ------ ------ ------- Total return+ (9.32%) (9.83%) (7.14%) - ------------------------------------ Ratios to Average Net Assets - ------------------------------------ Expenses 0.25%(b) 0.87%(b) 0.00%(b) - ------------------------------------ Net investment income 5.57%(b) 4.88%(b) 5.92%(b) - ------------------------------------ Expense waiver/reimbursement (a) 10.46%(b) 10.46%(b) 10.46%(b) - ------------------------------------ Supplemental Data - ------------------------------------ Net assets, end of period (000 omitted) $312 $2,456 $92 - ------------------------------------ Portfolio turnover rate 23% 23% 23% - ------------------------------------
* Reflects operations for the period from January 3, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union Virginia Municipal Bond Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Investment Investment Shares Shares Y Shares --------------- ---------------- ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, --------------- ---------------- ------------ 1994 1993* 1994 1993* 1994** - ------------------------ ------ ------ ------- ------ ------------ Net asset value, begin- ning of period $10.19 $10.00 $10.19 $10.00 $ 9.83 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.47 0.20 0.42 0.17 0.41 - ------------------------ Net realized and unrealized gain (loss) on investments (1.34) 0.19 (1.34) 0.19 (0.98) - ------------------------ ------ ------ ------ ------ ------ Total from investment operations (0.87) 0.39 (0.92) 0.36 (0.57) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.47) (0.20) (0.42) (0.17) (0.41) - ------------------------ ------ ------ ------ ------ ------ Net asset value, end of period $ 8.85 $10.19 $ 8.85 $10.19 $ 8.85 - ------------------------ ------ ------ ------ ------ ------ Total return+ (8.60%) 3.89% (9.13%) 3.66% (5.82%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.53% 0.25%(b) 1.12% 0.75%(b) 0.28%(b) - ------------------------ Net investment income 5.11% 4.64%(b) 4.54% 4.25%(b) 5.54%(b) - ------------------------ Expense waiver/reimbursement (a) 4.61% 7.50%(b) 4.61% 7.50%(b) 4.61%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $1,606 $1,306 $3,817 $2,235 $344 - ------------------------ Portfolio turnover rate 59% 0% 59% 0% 59% - ------------------------
* Reflects operations for the period from July 2, 1993 (commencement of operations) to December 31, 1993. ** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ First Union High Grade Tax Free Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Tax-Free Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Tax-Free Funds' Annual Report, which may be obtained from the Fund.
Class B Class A Investment Investment Shares Shares Y Shares -------------------------- ----------------- ------------ Year Ended Year Ended Year Ended December 31, December 31, December 31, -------------------------- ----------------- ------------ 1994 1993 1992** 1994 1993*** 1994* - ------------------------ ------- -------- ------- ------- ------- ------------ Net asset value, begin- ning of period $11.16 $10.42 $10.00 $11.16 $10.42 $10.93 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.52 0.54 0.51 0.46 0.47 0.46 - ------------------------ Net realized and unrealized gain (loss) on investments (1.37) 0.81 0.42 (1.37) 0.81 (1.14) - ------------------------ ------ ------ ------ ------ ------ ------ Total from investment operations (0.85) 1.35 0.93 (0.91) 1.28 (0.68) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.52) (0.54) (0.51) (0.46) (0.47) (0.46) - ------------------------ Distributions to share- holders from net realized gain on in- vestment transactions -- (0.07) -- -- (0.07) -- - ------------------------ ------ ------ ------ ------ ------ ------ Total distributions (0.52) (0.61) (0.51) (0.46) (0.54) (0.46) - ------------------------ ------ ------ ------ ------ ------ ------ Net asset value, end of period $ 9.79 $11.16 $10.42 $ 9.79 $11.16 $ 9.79 - ------------------------ ------ ------ ------ ------ ------ ------ Total return+ (7.71%) 13.25% 9.37% (8.24%) 12.41% (6.31%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.01% 0.85% 0.49%(b) 1.58% 1.35%(b) 0.76%(b) - ------------------------ Net investment income 5.04% 4.99% 5.79%(b) 4.47% 4.44%(b) 5.46%(b) - ------------------------ Expense waiver/reimbursement (a) 0.01% 0.22% 0.62%(b) 0.01% 0.22%(b) 0.01%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $57,676 $101,352 $90,738 $32,435 $41,030 $4,318 - ------------------------ Portfolio turnover rate 53% 14% 7% 53% 14% 53% - ------------------------
* Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. ** Reflects operations for the period from February 21, 1992 (commencement of operations) to December 31, 1992. *** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Tax-Free Funds' Annual Report for the fiscal year ended December 31, 1994, which can be obtained free of charge. - ------------------------ INVESTMENT ------------------------ - ------------------------ OBJECTIVES ------------------------ AND POLICIES First Union Single State Municipal Bond Funds seek current income exempt from federal regular income tax and, where applicable, state income taxes, consistent with preservation of capital. The High Grade Tax Free Fund seeks a high level of federally tax free income that is consistent with preservation of capital. In addition, the Florida Municipal Bond Fund intends to qualify as an investment exempt from the Florida state intangibles tax, and the North Carolina Municipal Bond Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. DESCRIPTION OF THE FUNDS Each Single State Municipal Bond Fund seeks current income which is exempt from federal regular income tax and (where applicable) the designated state income tax consistent with preservation of capital. The High Grade Tax Free Fund seeks a high level of federally tax-free income that is consistent with preservation of capital. In addition, the Florida Municipal Bond Fund intends to qualify as an investment exempt from the Florida state intangibles tax, and the North Carolina Municipal Bond Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax. As a matter of fundamental investment policy, each Single State Municipal Bond Fund will normally invest its assets so that at least 80% of its annual interest income is, or at least 80% of its net assets are invested in, obligations which provide interest income which is exempt from federal regular income taxes. The High Grade Tax Free Fund, as a matter of fundamental investment policy, will normally invest its assets so that at least 80% of its annual interest income is exempt from federal income taxes (including the alternative minimum tax). The interest retains its tax-free status when distributed to the Fund's shareholders. In addition, at least 65% of the value of each Single State Municipal Bond Fund's total assets will be invested in municipal bonds of the particular state after which the Fund is named. At least 65% of the value of the total assets of the High Grade Tax Free Fund will be invested in high grade bonds. High grade bonds mean: bonds insured by a municipal bond insurance company which is rated AAA by Standard & Poor's Ratings Group ("S&P") and/or Aaa by Moody's Investors Service, Inc. ("Moody's"); bonds rated A or better by S&P or Moody's; or, if unrated, of comparable quality as determined by the Adviser. The insurance guarantees the timely payment of principal and interest, but not the value of the municipal bonds or the shares of the Fund. See the section "Municipal Bond Insurance" in this prospectus for further information. To qualify as an investment exempt from the Florida state intangibles tax, the Florida Municipal Bond Fund's portfolio must consist entirely of investments exempt from the Florida state intangibles tax on the last business day of the calendar year. TYPES OF INVESTMENTS Each Single State Municipal Bond Fund seeks to achieve its investment objective by investing principally in municipal obligations, including industrial development bonds, of its designated state. The High Grade Tax Free Fund seeks to achieve its investment policy by investing primarily in a portfolio of high grade bonds. In addition, the Funds may invest in obligations issued by or on behalf of any state, territory, or possession of the United States, including the District of Columbia, or their political subdivisions or agencies and instrumentalities, the interest from which is exempt from federal (regular, if applicable) income tax. It is likely that shareholders who are subject to the alternative minimum tax will be required to include interest from a portion of the municipal securities owned by a Fund in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The municipal bonds in which the Single State Municipal Bond Funds will invest are subject to one or more of the following quality standards: rated Baa or better by Moody's or BBB or better by S&P or, if unrated, are determined by the Adviser to be of comparable quality to such ratings; insured by a municipal bond insurance company which is rated Aaa by Moody's or AAA by S&P; guaranteed at the time of purchase by the U.S. government as to the payment of principal and interest; or fully collateralized by an escrow of U.S. government securities. Bonds rated BBB by S&P or Baa by Moody's have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. If any security owned by a Fund loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. If ratings made by Moody's or S&P change because of changes in those organizations or their ratings systems, the Funds will try to use comparable ratings as standards in accordance with the Funds' investment objectives. A description of the rating categories is contained in the Appendix of the Statement of Additional Information for each Fund. Other types of investments include: participation interests in any of the above obligations. (Participation interests may be purchased from financial institutions such as commercial banks, savings and loan associations and insurance companies, and give a Fund an undivided interest in particular municipal securities); variable rate municipal securities. (Variable rate securities offer interest rates which are tied to a money market rate, usually a published interest rate or interest rate index or the 91-day U.S. Treasury bill rate. Many of these securities are subject to prepayment of principal on demand by the Fund, usually in seven days or less); and municipal leases issued by state and local governments or authorities to finance the acquisition of equipment and facilities. The Fund may purchase municipal securities in the form of participation interests which represent undivided proportional interests in lease payments by a governmental or non-profit entity. The lease payments and other rights under the lease provide for and secure the payments on the certificates. Lease obligations may be limited by municipal charter or the nature of the appropriation for the lease. In particular, lease obligations may be subject to periodic appropriation. If the entity does not appropriate funds for future lease payments, the entity cannot be compelled to make such payments. Furthermore, a lease may provide that the certificate trustee cannot accelerate lease obligations upon default. The trustee would only be able to enforce lease payments as they become due. In the event of a default or failure of appropriation, it is unlikely that the trustee would be able to obtain an acceptable substitute source of payment or that the substitute source of payment would generate tax-exempt income. TEMPORARY INVESTMENTS During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, a Fund may temporarily invest in short-term tax- exempt or taxable investments. These temporary investments include: notes issued by or on behalf of municipal or corporate issuers; obligations issued or guaranteed by the U.S. government, its agencies, or instrumentalities; other debt securities; commercial paper; bank certificates of deposit; shares of other investment companies; and repurchase agreements. There are no rating requirements applicable to temporary investments. However, the Adviser will limit temporary investments to those it considers to be of comparable quality to the Fund's primary investments. Although the Funds are permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal regular income tax, where applicable. However, certain temporary investments will generate income which is subject to state taxes. The High Grade Tax Free Fund may also purchase instruments having variable rates of interest. One example is variable amount demand master notes. These notes represent a borrowing arrangement between a commercial paper issuer (borrower) and an institutional lender, such as the Fund and are payable upon demand. The underlying amount of the loan may vary during the course of the contract, as may the interest on the outstanding amount, depending on a stated short-term interest rate index. MUNICIPAL BONDS Municipal bonds are debt obligations issued by the state or local entities to support a government's general financial needs or special projects, such as housing projects or sewer works. Municipal bonds include industrial development bonds issued by or on behalf of public authorities to provide financing aid to acquire sites or construct or equip facilities for privately or publicly owned corporations. The two principal classifications of municipal bonds are "general obligation" and "revenue" bonds. General obligation bonds are secured by the issuer's pledge of its full faith and credit and taxing power for the payment of principal and interest. Revenue bonds are paid off only with the revenue generated by the project financed by the bond or other specified sources of revenue. For example, in the case of a bridge project, proceeds from the tolls would go directly to retiring the bond issue. Thus, unlike general obligation bonds, revenue bonds do not represent a pledge of credit or create any debt of or charge against the general revenues of a municipality or public authority. The High Grade Tax Free Fund may invest more than 25% of its total assets in industrial development bonds as long as they are not from the same facility or similar types of facilities. RISK FACTORS Bond yields are dependent on several factors including market conditions, the size of an offering, the maturity of the bond, ratings of the bond and the ability of issuers to meet their obligations. There is no limit on the maturity of the bonds purchased by the Funds. Because the prices of bonds fluctuate inversely in relation to the direction of interest rates, the prices of longer term bonds fluctuate more widely in response to market interest rate changes. A Fund's concentration in securities issued by its designated state and that state's political subdivisions provides a greater level of risk than a fund which is diversified across numerous states and municipal entities. An expanded discussion of the risks associated with the purchase of the designated state's municipal bonds is contained in the respective Statements of Additional Information. Although the Funds will not purchase securities rated below BBB by S&P or Baa by Moody's (i.e., junk bonds), the Funds are not required to dispose of securities that have been downgraded subsequent to their purchase. If the municipal obligations held by a Fund (because of adverse economic conditions in a particular state, for example) are downgraded, the Fund's concentration in securities of that state may cause the Fund to be subject to the risks inherent in holding material amounts of low- rated debt securities in its portfolio. MUNICIPAL BOND INSURANCE The High Grade Tax Free Fund will require municipal bond insurance when purchasing municipal securities which would not otherwise meet the Fund's quality standards. The High Grade Tax Free Fund may also require insurance when, in the opinion of the Adviser, such insurance would benefit the Fund (for example, through improvement of portfolio quality or increased liquidity of certain securities). The purpose of municipal bond insurance is to guarantee the timely payment of principal at maturity and interest. Securities in the High Grade Tax Free Fund's portfolio may be insured in one of two ways: (1) by a policy applicable to a specific security, obtained by the issuer of the security or by a third party ("Issuer-Obtained Insurance") or (2) under master insurance policies issued by municipal bond insurers, purchased by the Fund (the "Policies"). If a security's coverage is Issuer- Obtained, then that security does not need to be covered in the Policies. The High Grade Tax Free Fund may purchase Policies from Municipal Bond Investors Assurance Corp., AMBAC Indemnity Corporation, and Financial Guaranty Insurance Company, or any other municipal bond insurer which is rated Aaa by Moody's or AAA by S&P. A more detailed description of these insurers may be found in the High Grade Tax Free Fund's Statement of Additional Information. Annual premiums for these Policies are paid by the Fund and are estimated to range from 0.10% to 0.25% of the value of the municipal securities covered under the Policies, with an average annual premium rate of approximately 0.175%. While the insurance feature reduces financial risk, the cost thereof and the restrictions on investments imposed by the guidelines in the Policies reduce the yield to shareholders. - ------------------------ OTHER INVESTMENT ------------------------ - ------------------------ POLICIES ------------------------ The Funds have adopted the following practices for specific types of investments. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Funds' risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Funds to sell the security in the open market in the case of a default. In such a case, the Funds may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Funds purchase securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause the Funds to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, the Funds may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend their portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, the Funds will not lend any of their assets except portfolio securities up to one-third (in the case of the Single State Municipal Bond Funds) and 15% (in the case of the High Grade Tax Free Fund) of the value of their total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) no Fund will own more than 3% of the total outstanding voting stock of any one investment company, (2) no Fund may invest more than 5% of its total assets in any one investment company and (3) no Fund may invest more than 10% of its total assets in investment companies in general. The Adviser will waive its investment advisory fee on assets invested in securities of other open end investment companies. OPTIONS AND FUTURES The Funds, with the exception of the High Grade Tax Free Fund, may engage in options and futures transactions. Options and futures transactions are intended to enable a Fund to manage market or interest rate risk, and the Funds do not use these transactions for speculation or leverage. The Funds may attempt to hedge all or a portion of their portfolios through the purchase of both put and call options on their portfolio securities and listed put options on financial futures contracts for portfolio securities. The Funds may also write covered call options on their portfolio securities to attempt to increase their current income. The Funds will maintain their positions in securities, option rights, and segregated cash subject to puts and calls until the options are exercised, closed, or have expired. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. The Funds may purchase listed put options on financial futures contracts. These options will be used only to protect portfolio securities against decreases in value resulting from market factors such as an anticipated increase in interest rates. The Funds may write (i.e., sell) covered call and put options. By writing a call option, a Fund becomes obligated during the term of the option to deliver the securities underlying the option upon payment of the exercise price. By writing a put option, a Fund becomes obligated during the term of the option to purchase the securities underlying the option at the exercise price if the option is exercised. The Funds also may write straddles (combinations of covered puts and calls on the same underlying security). The Funds may only write "covered" options. This means that so long as a Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. A Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of the put option, it deposits and maintains with its custodian in a segregated account liquid assets having a value equal to or greater than the exercise price of the option. The principal reason for writing call or put options is to obtain, through a receipt of premiums, a greater current return than would be realized on the underlying securities alone. The Funds receive a premium from writing a call or put option which they retain whether or not the option is exercised. By writing a call option, the Funds might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Funds might become obligated to purchase the underlying securities for more than their current market price upon exercise. A futures contract is a firm commitment by two parties: the seller, who agrees to make delivery of the specific type of instrument called for in the contract ("going short"), and the buyer, who agrees to take delivery of the instrument ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt instruments issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. If a Fund would enter into financial futures contracts directly to hedge its holdings of fixed income securities, it would enter into contracts to deliver securities at an undetermined price (i.e., "go short") to protect itself against the possibility that the prices of its fixed income securities may decline during the Fund's anticipated holding period. A Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. The Funds may also enter into financial futures contracts and write options on such contracts. The Funds intend to enter into such contracts and related options for hedging purposes. The Funds will enter into futures on securities or index-based futures contracts in order to hedge against changes in interest rates or securities prices. A futures contract on securities is an agreement to buy or sell securities during a designated month at whatever price exists at that time. A futures contract on a securities index does not involve the actual delivery of securities, but merely requires the payment of a cash settlement based on changes in the securities index. The Funds do not make payment or deliver securities upon entering into a futures contract. Instead, they put down a margin deposit, which is adjusted to reflect changes in the value of the contract and which remains in effect until the contract is terminated. The Funds may sell or purchase other financial futures contracts. When a futures contract is sold by a Fund, the profit on the contract will tend to rise when the value of the underlying securities declines and to fall when the value of such securities increases. Thus, the Funds sell futures contracts in order to offset a possible decline in the profit on their securities. If a futures contract is purchased by a Fund, the value of the contract will tend to rise when the value of the underlying securities increases and to fall when the value of such securities declines. The Funds may enter into closing purchase and sale transactions in order to terminate a futures contract and may buy or sell put and call options for the purpose of closing out their options positions. The Funds' ability to enter into closing transactions depends on the development and maintenance of a liquid secondary market. There is no assurance that a liquid secondary market will exist for any particular contract or at any particular time. As a result, there can be no assurance that the Funds will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Funds are not able to enter into an offsetting transaction, the Funds will continue to be required to maintain the margin deposits on the contract and to complete the contract according to its terms, in which case it would continue to bear market risk on the transaction. RISK CHARACTERISTICS OF OPTIONS AND FUTURES Although options and futures transactions are intended to enable the Funds to manage market or interest rate risks, these investment devices can be highly volatile, and the Funds' use of them can result in poorer performance (i.e., the Funds' return may be reduced). The Funds' attempt to use such investment devices for hedging purposes may not be successful. Successful futures strategies require the ability to predict future movements in securities prices, interest rates and other economic factors. When the Funds use financial futures contracts and options on financial futures contracts as hedging devices, there is a risk that the prices of the securities subject to the financial futures contracts and options on financial futures contracts may not correlate perfectly with the prices of the securities in the Funds' portfolios. This may cause the financial futures contract and any related options to react to market changes differently than the portfolio securities. In addition, the Adviser could be incorrect in its expectations and forecasts about the direction or extent of market factors, such as interest rates, securities price movements, and other economic factors. Even if the Adviser correctly predicts interest rate movements, a hedge could be unsuccessful if changes in the value of a Fund's futures position did not correspond to changes in the value of its investments. In these events, the Funds may lose money on the financial futures contracts or the options on financial futures contracts. It is not certain that a secondary market for positions in financial futures contracts or for options on financial futures contracts will exist at all times. Although the Adviser will consider liquidity before entering into financial futures contracts or options on financial futures contracts transactions, there is no assurance that a liquid secondary market on an exchange will exist for any particular financial futures contract or option on a financial futures contract at any particular time. The Funds' ability to establish and close out financial futures contracts and options on financial futures contract positions depends on this secondary market. If a Fund is unable to close out its position due to disruptions in the market or lack of liquidity, the Fund may lose money on the futures contract or option, and the losses to the Fund could be significant. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money or pledge securities, except under certain circumstances each Fund may borrow up to one-third of the value of its total assets and pledge assets to secure such borrowings. SELLING SHORT The High Grade Tax Free Fund will not make short sales of securities, except in certain circumstances. RESTRICTED AND ILLIQUID SECURITIES The High Grade Tax Free Fund will not invest more than 10% of its total assets in securities subject to restrictions on resale under federal securities laws. The High Grade Tax Free Fund will not invest more than 15% of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities not determined by the Trustees to be liquid. NON-DIVERSIFICATION Each of the Single State Municipal Bond Funds is a non-diversified portfolio of an investment company and as such, there is no limit on the percentage of assets which can be invested in any single issuer. An investment in a Fund, therefore, will entail greater risk than would exist in a diversified investment company because the higher percentage of investments among fewer issuers may result in greater fluctuation in the total market value of the Fund's portfolio. Each of the Single State Municipal Bond Funds intends to comply with Subchapter M of the Internal Revenue Code which requires that at the end of each quarter of each taxable year, with regard to at least 50% of the Fund's total assets, no more than 5% of the total assets may be invested in the securities of a single issuer and that with respect to the remainder of the Fund's total assets, no more than 25% of its total assets are invested in the securities of a single issuer. The following investment limitations may be changed by the Trustees without shareholder approval. RESTRICTED AND ILLIQUID SECURITIES The Single State Municipal Bond Funds may not invest more than 15% of their net assets in securities which are subject to restrictions on resale under federal securities law. Certain restricted securities which the Trustees deem to be liquid will be excluded from this limitation. The Single State Municipal Bond Funds will limit investments in illiquid securities, including certain restricted securities or municipal leases not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice, to 15% of their net assets. NEW ISSUERS The Single State Municipal Bond Funds will not invest more than 5% of the value of their total assets in securities of issuers (or guarantors, where applicable) which have records of less than three years of continuous operations, including the operation of any predecessor. WARRANTS The High Grade Tax Free Fund may not invest more than 5% of its assets in warrants. No more than 2% of this 5% may be in warrants which are not listed on the New York or American Stock Exchanges. - ------------------------ SHAREHOLDER GUIDE ------------------------ - ------------------------ ------------------------ CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing either Class A Shares or Class B Shares. Your decision will be based on the amount of your intended purchase and how long you expect to hold the Shares. Each Fund offers two types of Investment Shares: Class A Shares and Class B Shares. Each Share of the Fund represents an identical interest in the investment portfolio of the Fund and has the same rights. The difference between Class A Shares and Class B Shares is based on purchasing arrangements and distribution and shareholder services expenses. Class A Shares have a sales charge included at the time of purchase and are subject to a Rule 12b-1 distribution fee of 0.25 of 1%. This means that investors can purchase fewer Class A Shares for the same initial investment than Class B Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class B Shares impose a maximum contingent deferred sales charge ("CDSC") of 5%. In addition, Class B Shares impose a CDSC on most redemptions made within seven years of purchase, and have higher distribution costs resulting from a Rule 12b-1 distribution fee of 0.75 of 1% and a shareholder services fee of 0.25 of 1%. In addition, at the end of the seven year period, Class B Shares may automatically convert to Class A Shares and thus be subject to lower Rule 12b-1 distribution fees. This means that investors may purchase more Class B Shares than Class A Shares for the same initial investment, but will receive lower dividends per Share. Investors should consider whether, during the anticipated life of their investment in the Funds, the accumulated Rule 12b-1 fees and the CDSC and shareholder services fee on Class B Shares would be less than the initial sales charge and accumulated Rule 12b-1 fees on Class A Shares purchased at the same time. Investors must also consider how that differential would be offset by the higher yield of Class A Shares. SHARE PRICE CALCULATION The net asset value of a Fund Share equals the market value of all the Fund's portfolio securities divided by the total Shares outstanding. It is also the bid price. The offering price is quoted after adding a sales charge to the net asset value. Purchases, redemptions, and exchanges are all based on net asset value. (The purchase price of Class A Shares adds an applicable sales charge, and the redemption proceeds of Class B Shares deduct an applicable CDSC.) The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares and Class B Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares) for each class of shares. The net asset value for each Fund will fluctuate for all three classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return, yield, or tax equivalent yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Class A Shares and Class B Shares. It is generally reported using total return, yield, and tax equivalent yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yields of Class A Shares and Class B Shares are calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. Tax equivalent yield is calculated like the yield described above, except that for any given tax bracket, net investment income will be calculated as the sum of any taxable income and the tax exempt income divided by the difference between 1 and the federal tax rates for taxpayers in that tax bracket. The yield and tax equivalent yield do not necessarily reflect income actually earned by Class A Shares and Class B Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Performance information for the Class A Shares and Class B Shares reflects the effect of a sales charge which, if excluded, would increase the total return, yield, and tax equivalent yield. Total return, yield, and tax equivalent yield will be calculated separately for Class A Shares, Class B Shares, and Y Shares of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee and Class B Shares are subject to a Rule 12b-1 fee and a shareholder services fee, the yield and tax equivalent yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class B Shares. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. - ------------------------ HOW TO BUY ------------------------ - ------------------------ SHARES ------------------------ Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (in the case of Class A Shares), or (ii) on a contingent deferred basis (in the case of Class B Shares). MINIMUM INVESTMENT You may invest as often as you want in the Funds. There is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Mutual Funds Group of First Union Brokerage Services ("FUBS"), a subsidiary of First Union, at 1-800-326-3241. Subsequent investments may be in any amounts. WHAT SHARES COST Class A Shares are sold at their net asset value plus a sales charge as follows: Sales Charge as Sales Charge as a a Percentage of Percentage of Net Amount of Transaction Public Offering Price Amount Invested - --------------------- --------------------- ----------------- $ 0-$ 99,999 4.75% 4.99% $ 100,000-$ 249,999 3.75% 3.90% $ 250,000-$ 499,999 3.00% 3.10% $ 500,000-$ 999,999 2.00% 2.04% $1,000,000-$2,499,999 1.00% 1.01% $2,500,000 and above 0.25% 0.25% Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. (the "distributor" or "FSC") and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. Sales charges may be reduced in some cases. You may be entitled to a reduction if: (1) you make a single large purchase, (2) you, your spouse and/or children (under 21 years) make Fund purchases on the same day, (3) you make an additional purchase to add to an existing account, (4) you sign a letter of intent indicating your intention to purchase at least $100,000 of Shares over the next 13 months, (5) you reinvest in a Fund within 30 days of redemption, or (6) you combine purchases of two or more First Union Funds which include front- end sales charges. In addition, no front-end sales charges are imposed on Class A shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non- qualified employee benefit and savings plans which make shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker-dealers or other financial intermediaries whose employee benefit plan clients purchase shares under the foregoing front-end sales charge exemption in an amount up to .50 of 1% of the net asset value of shares purchased. These payments are subject to reclaim in the event shares are redeemed within 12 months after purchase. In all of these cases, you must notify the distributor of your intentions in writing in order to qualify for a sales charge reduction. For more information, consult the Funds' Statements of Additional Information or the distributor. Class B Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within seven years of their purchase will be subject to a CDSC according to the following schedule (applicable only to purchases beginning September 1, 1994): Year of Redemption Contingent Deferred After Purchase Sales Charge - ------------------ ------------------- First 5.0% Second 4.0% Third 3.0% Fourth 3.0% Fifth 2.0% Sixth 1.0% Seventh 1.0% No CDSC will be imposed on: (1) the portion of redemption proceeds attributable to increases in the value of the account due to increases in the net asset value per Share, (2) Shares acquired through reinvestment of dividends and capital gains, (3) Shares held for more than seven years after the end of the calendar month of acquisition, (4) accounts following the death or disability of a shareholder, or (5) minimum required distributions to a shareholder over the age of 70 1/2 from an IRA or other retirement plan. CONVERSION FEATURE Class B Shares include all Shares purchased pursuant to the deferred sales charge alternative which have been outstanding for less than the period ending seven years after the end of the month in which the shareholder's order to purchase Class B Shares was accepted. At the end of this seven year period, Class B Shares may automatically convert to Class A Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class B Shares. Such conversion will be on the basis of the relative net asset values of the two classes, without the imposition of any sales load, fee, or other charge. The purpose of the conversion feature is to relieve the holders of the Class B Shares that have been outstanding for a period of time sufficient for the distributor to have been compensated for distribution expenses related to the Class B Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class A Shares, Class B Shares purchased through the reinvestment of dividends and distributions paid on Class B Shares in a shareholder's Fund account will be considered to be held in a separate sub- account. Each time any Class B Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class A Shares, an equal pro rata portion of the Class B Shares in the sub-account will also convert to Class A Shares. The availability of the conversion feature is subject to the granting of an exemptive order (the "Order") by the Securities and Exchange Commission (the "SEC") or the adoption of a rule permitting such conversion. In the event that the Order or rule ultimately issued by the SEC requires any conditions additional to those described in this prospectus, shareholders will be notified. BY TELEPHONE OR IN PERSON You may purchase Class A Shares and Class B Shares by telephone from the Mutual Funds Group of FUBS at 1-800-326-3241 or you may place the order in person at any First Union branch location. Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. All purchase orders received prior to 4:00 p.m. (Eastern time) on a regular business day are processed at that day's offering price. Payment is required within five business days. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued, except with respect to investors who invest $1,000,000 or more in Class A Shares of the Florida Municipal Bond Fund. In such case, share certificates may be issued upon request by contacting the Fund. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. DEALER CONCESSION For sales of Shares of the Funds, a dealer will normally receive up to 85% of the applicable sales charge. Any portion of the sales charge which is not paid to a dealer will be retained by the distributor. However, the distributor, in its sole discretion, may uniformly offer to pay to all dealers selling Shares of the Funds, all or a portion of the sales charge it normally retains. If accepted by the dealer, such additional payments will be predicated upon the amount of Fund Shares sold. The sales charge for Shares sold other than through registered broker/dealers will be retained by FSC. FSC may pay fees to banks out of the sales charge in exchange for sales and/or administrative services performed on behalf of the bank's customers in connection with the initiation of customer accounts and purchases of Shares. From time to time, the distributor will conduct sales programs or contests that compensate brokers with cash or non-cash items, such as merchandise and attendance at sales seminars in resort locations. The cost of such compensation is borne by the distributor and is not a Fund expense. HOW TO CONVERT - ------------------------ YOUR INVESTMENT ------------------------ - ------------------------ FROM ONE FIRST ------------------------ UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call FUBS at 1-800-326-3241 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Class A Shares of one First Union Fund for Class A Shares of any other First Union Fund, or Class B Shares of one First Union Fund for Class B Shares of any other First Union Fund by calling toll free 1-800-326-3241 or by writing to FUBS. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value, and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. The exchange of Class B Shares will not be subject to a CDSC. However, if the shareholder redeems Class B Shares within seven years of the original purchase, a CDSC will be imposed. For purposes of computing the CDSC, the length of time the shareholder has owned Class B Shares will be measured from the date of original purchase and will not be affected by the exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. - ------------------------ HOW TO ------------------------ - ------------------------ REDEEM SHARES ------------------------ Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less, in the case of Class B Shares, any applicable CDSC. You may redeem Shares in three ways: (1) by telephoning FUBS at 1-800-326-3241, (2) by written request to FUBS or Federated Services Company, c/o State Street Bank and Trust Company, P.O. Box 8609, Boston, Massachusetts, 02266-8609, or (3) in person at First Union. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record, normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. - ------------------------ ADDITIONAL ------------------------ - ------------------------ SHAREHOLDER ------------------------ SERVICES TELEPHONE SERVICES You may authorize electronic transfers of money to purchase Shares in any amount or to redeem any or all Shares in an account. The service may be used like an "electronic check" to move money between a bank account and an account in a Fund with a single telephone call. SYSTEMATIC INVESTMENT PLAN You may arrange for systematic monthly or quarterly investments in your account in amounts of $25 or more by directly debiting your bank account. SYSTEMATIC CASH WITHDRAWAL PLAN When an account of $10,000 or more is opened or when an existing account reaches that size, you may participate in a Fund's Systematic Cash Withdrawal Plan by filling out the appropriate part of the share purchase application. Under this plan, you may receive (or designate a third party to receive) a monthly or quarterly check in a stated amount of not less than $25. Fund shares will be redeemed as necessary to meet withdrawal payments. All participants must elect to have their dividends and capital gain distributions reinvested automatically. Any applicable Class B Shares CDSC will be waived with respect to redemptions occurring under a Systematic Cash Withdrawal Plan during a calendar year to the extent that such redemptions do not exceed 10% of (i) the initial value of the account, plus (ii) the value, at the time of purchase, of any subsequent investments. - ------------------------ MANAGEMENT ------------------------ - ------------------------ OF FIRST ------------------------ UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. Robert S. Drye is a Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1968. Since 1989, Mr. Drye has served as a portfolio manager for several of the First Union Funds and for certain common trust funds. Prior to 1989, Mr. Drye worked as a marketing specialist with FUBS. Mr. Drye has managed the South Carolina Municipal Bond Fund since its inception in January 1994. In addition, Mr. Drye has been the portfolio manager for the Florida Municipal Bond Fund since its inception in July 1993. Mr. Drye has also managed the High Grade Tax Free Fund since its inception in February 1992. Richard K. Marrone is a Vice President of First Union National Bank of North Carolina, N.A. Mr. Marrone joined First Union in May 1993 with eleven years of experience managing fixed income assets at Woodbridge Capital Management, a subsidiary of Comerica Bank, N.A. Mr. Marrone is responsible for the portfolio management of several First Union Funds and certain common trust funds. Mr. Marrone has served as portfolio manager of the North Carolina Municipal Bond Fund since May 1993, and portfolio manager of the Georgia Municipal Bond Fund since its inception in July 1993. Charles E. Jeanne joined First Union National Bank of North Carolina, N.A. in July 1993. Prior to joining First Union, Mr. Jeanne served as a trader/portfolio manager for First American Bank where he was responsible for individual accounts and common trust funds. Mr. Jeanne has been the portfolio manager for the Virginia Municipal Bond Fund since its inception in July 1993. DISTRIBUTION OF INVESTMENT SHARES FSC, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Each Investment Shares Class of a Fund has adopted a separate plan for distribution of Shares permitted by Rule 12b-1 under the Investment Company Act of 1940 (the "Plans"), whereby each Fund has authorized a daily expense ("Rule 12b-1 fee") at an annual rate of 0.75 of 1% of the average daily net asset value of the Fund's respective class to finance the sale of Shares. It is currently intended that annual Rule 12b-1 fees will be limited for the foreseeable future to payments to the distributor equal to 0.25 of 1% for Class A Shares and 0.75 of 1% for Class B Shares of each Fund's respective average daily net asset value. The distributor may pay all or a portion of the Rule 12b-1 fee to compensate selected brokers and financial institutions for selling Shares or for administrative services rendered in connection with the Shares. The Funds make no payments in connection with the sale of Shares other than the Rule 12b-1 fees paid to the distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class B Shares. Except as set forth in the next paragraph, the Funds do not pay for unreimbursed expenses of the distributor. Since the Funds' Plans are "compensation" type plans, however, future Rule 12b-1 fees may permit recovery of such amounts or may result in a profit to the distributor. The distributor may sell, assign, or pledge its right to receive Rule 12b-1 fees and CDSCs to finance payments made to brokers (including FUBS) in connection with the sale of Class B Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class B Shares at any given time may exceed the Rule 12b-1 fees and payments received pursuant to CDSCs. These unrecovered amounts, plus interest thereon, will be carried forward and paid from future Rule 12b-1 fees and payments received through CDSCs. If a Plan were terminated or not continued, the Funds would not be contractually obligated to pay for any expenses not previously reimbursed by the Funds or recovered through CDSCs. FSC, from time to time, may pay brokers additional sums of cash or promotional incentives based upon the amount of Shares sold. Such payments, if made, will be in addition to amounts paid under the Plans and will not be an expense of the Funds. FUND ADMINISTRATION Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. The Funds may pay a shareholder servicing agent (the "Shareholder Servicing Agent") a fee based on average daily net asset value for Class B Shares of the Funds for which the Shareholder Servicing Agent provides shareholder services. As such, the Shareholder Servicing Agent provides shareholder services which include, but are not limited to, distributing prospectuses and other information, providing shareholder assistance, and communicating or facilitating purchases and redemptions of Class B Shares. The Funds may pay the Shareholder Servicing Agent a fee equal to 0.25 of 1% of the average daily net asset value of Class B Shares for which the Shareholder Servicing Agent provides shareholder services. The Shareholder Servicing Agent may voluntarily choose to waive all or portion of its fee at any time. First Union Brokerage Services, First Union, and other financial institutions may serve as Shareholder Servicing Agent. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. - ------------------------ FEES AND EXPENSES ------------------------ - ------------------------ ------------------------ Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.50 of 1% of each of the Funds' average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust - ------------------- ----------------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND INVESTMENT SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares and Class B Shares. In addition, the Funds' expenses under the Shareholder Services Plan are incurred solely by the Class B Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. - ------------------------ SHAREHOLDER ------------------------ - ------------------------ RIGHTS AND ------------------------ PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 7, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of approximately 133,591.799 Shares (67.297%) of the Florida Municipal Bond Fund--Y Shares; approximately 132,561.656 Shares (99.934%) of the Georgia Municipal Bond Fund--Y Shares; approximately 13,856.813 Shares (56.260%) of the South Carolina Municipal Bond Fund--Y Shares; approximately 33,347.986 Shares (73.387%) of the Virginia Municipal Bond Fund--Y Shares; and 398,873.093 Shares (91.900%) of the High Grade Tax Free Fund--Y Shares; and First Union National Bank--Capital Management Group, for the exclusive benefit of Lawrence and Jean Farry, Charlotte, North Carolina, owned approximately 6,314.849 Shares (25.639%) of the South Carolina Municipal Bond Fund--Y Shares; and, for the exclusive benefit of Thomas B. Carr and Louise B. Carr of Wylie, South Carolina, owned approximately 16,326.787 Shares (44.738%) of the South Carolina Municipal Bond Fund--Class A Investment Shares; and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. - ------------------------ DISTRIBUTIONS ------------------------ - ------------------------ AND TAXES ------------------------ Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared daily and paid monthly. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or FUBS in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. - ------------------------ TAX INFORMATION ------------------------ - ------------------------ ------------------------ Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Shareholders of the Funds are not required to pay the federal regular income tax on any dividends and other distributions received from a Fund that represent net interest on tax-exempt municipal bonds. However, under the Tax Reform Act of 1986, dividends representing net interest earned on some municipal bonds may be included in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The alternative minimum tax, up to 28% of alternative minimum taxable income for individuals and 20% for corporations, applies when it exceeds the regular tax for the taxable year. Alternative minimum taxable income is equal to the adjusted income of the taxpayer increased by certain "tax preference" items not included in regular taxable income and reduced by only a portion of the deductions allowed in the calculation of the regular tax. The Tax Reform Act of 1986 treats interest on certain "private activity" bonds issued after August 7, 1986, as a tax preference item. Unlike traditional governmental purpose municipal bonds, which finance roads, schools, libraries, prisons, and other public facilities, private activity bonds provide benefits to private parties. The Funds may purchase all types of municipal bonds, including "private activity" bonds. Thus, should a Fund purchase any such bonds, a portion of the Fund's dividends may be treated as a tax preference item. In addition, in the case of a corporate shareholder, dividends of a Fund which represent interest on municipal bonds may be subject to the 20% corporate alternative minimum tax because the dividends are included in a corporation's "adjusted current earnings." The corporate alternative minimum tax treats 75% of the excess of a taxpayer's pre-tax "adjusted current earnings" over the taxpayer's alternative minimum taxable income as a tax preference item. "Adjusted current earnings" is based upon the concept of a corporation's "earnings and profits." Since "earnings and profits" generally includes the full amount of any Fund dividend, and alternative minimum taxable income does not include the portion of the Fund's dividend attributable to municipal bonds which are not private activity bonds, the difference will be included in the calculation of the corporation's alternative minimum tax. Shareholders are urged to consult their own tax advisers to determine whether they are subject to alternative minimum tax or the corporate alternative minimum tax and, if so, the tax treatment of dividends paid by the Funds. Dividends of a Fund representing net interest income earned on some temporary investments, income earned on options transactions, and any realized net short- term gains are taxed as ordinary income. Distributions representing net long- term capital gains realized by the Funds, if any, will be taxable as long-term capital gains regardless of the length of time shareholders have held their Shares. These tax consequences apply whether dividends are received in cash or as additional Shares. Information on the tax status of dividends and distributions is provided annually. Set forth below are brief descriptions of the personal income tax status of an investment in each of the Single State Municipal Bond Funds under, respectively, Florida, Georgia, North Carolina, South Carolina, and Virginia tax laws currently in effect. Income from a Fund is not necessarily free from state income taxes in states other than its designated state. State laws differ on this issue, and shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local laws. A statement setting forth the state income tax status of all distributions made during each calendar year will be sent to shareholders annually. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE FLORIDA MUNICIPAL BOND FUND Florida does not currently impose an income tax on individuals. Thus, individual shareholders of the Florida Municipal Bond Fund will not be subject to any Florida state income tax on distributions received from the Florida Municipal Bond Fund. However, certain distributions will be taxable to corporate shareholders which are subject to Florida corporate income tax. Florida currently imposes an intangibles tax at the annual rate of 0.20% on certain securities and other intangible assets owned by Florida residents. Certain types of tax exempt securities of Florida issuers, U.S. government securities and tax exempt securities issued by certain U.S. territories and possessions are exempt from this intangibles tax. Shares of the Florida Municipal Bond Fund will also be exempt from the Florida intangibles tax if the portfolio consists exclusively of securities exempt from the intangibles tax on the last business day of the calendar year. If the portfolio consists of any assets which are not so exempt on the last business day of the calendar year, however, only the portion of the Shares of the Florida Municipal Bond Fund which relate to securities issued by the United States and its possessions and territories will be exempt from the Florida intangibles tax, and the remaining portion of such Shares will be fully subject to the intangibles tax, even if they partly relate to Florida tax exempt securities. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE GEORGIA MUNICIPAL BOND FUND Under existing Georgia law, shareholders of the Georgia Municipal Bond Fund will not be subject to individual or corporate Georgia income taxes on distributions from the Georgia Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest-bearing obligations issued by or on behalf of the State of Georgia or its political subdivisions, or (2) interest on obligations of the United States or of any other issuer whose obligations are exempt from state income taxes under federal law. Distributions, if any, derived from capital gains or other sources generally will be taxable for Georgia income tax purposes to shareholders of the Georgia Municipal Bond Fund who are subject to the Georgia income tax. For purposes of the Georgia intangibles tax, Shares of the Georgia Municipal Bond Fund likely are taxable (at the rate of 10 cents per $1,000 in value of the Shares held on January 1 of each year) to shareholders who are otherwise subject to such tax. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE NORTH CAROLINA MUNICIPAL BOND FUND Under existing North Carolina law, shareholders of the North Carolina Municipal Bond Fund will not be subject to individual or corporate North Carolina income taxes on distributions from the North Carolina Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest on obligations issued by North Carolina and political subdivisions thereof or (2) interest on obligations of the United States or its territories or possessions. Distributions, if any, derived from capital gains or other sources generally will be taxable for North Carolina income tax purposes to shareholders of the North Carolina Municipal Bond Fund who are subject to the North Carolina income tax. North Carolina currently imposes an intangibles tax (at the rate of 25 cents per $100 in value of the shares held on December 31 of each year) on all shares of stock, including mutual funds. However, shareholders of North Carolina Municipal Bond Fund may exclude from share value that proportion of the total share value which is attributable to direct obligations of the State of North Carolina, its subdivisions, and the United States held in the North Carolina Municipal Bond Fund as of December 31 of the taxable year. The North Carolina Municipal Bond Fund will annually furnish to its shareholders a statement supporting the proper allocation. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE SOUTH CAROLINA MUNICIPAL BOND FUND Under existing South Carolina law, shareholders of the South Carolina Municipal Bond Fund will not be subject to individual or corporate South Carolina income taxes on South Carolina Municipal Bond Fund distributions to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to (1) interest on obligations of the State of South Carolina, or any of its political subdivisions, (2) interest on obligations of the United States, or (3) interest on obligations of any agency or instrumentality of the United States that is prohibited by federal law from being taxed by a state or any political subdivision of a state. Distributions, if any, derived from capital gains or other sources, generally will be taxable for South Carolina income tax purposes to shareholders of South Carolina Municipal Bond Fund who are subject to South Carolina income tax. ADDITIONAL TAX INFORMATION FOR SHAREHOLDERS OF THE VIRGINIA MUNICIPAL BOND FUND Under existing Virginia law, shareholders of the Virginia Municipal Bond Fund will not be subject to individual or corporate Virginia income taxes on distributions received from the Virginia Municipal Bond Fund to the extent that such distributions represent exempt-interest dividends for federal income tax purposes that are attributable to interest earned on (1) obligations issued by or on behalf of the Commonwealth of Virginia or any political subdivision thereof, or (2) obligations issued by a territory or possession of the United States or any subdivision thereof which federal law exempts from state income taxes. Distributions, if any, derived from capital gains or other sources generally will be taxable for Virginia income tax purposes to shareholders of the Virginia Municipal Bond Fund who are subject to Virginia income tax. - ------------------------ OTHER CLASSES ------------------------ - ------------------------ OF SHARES ------------------------ First Union Tax-Free Funds offer three classes of shares: Class A Shares and Class B Shares for individuals and other customers of First Union and Y Shares for institutional investors. Y Shares are sold to accounts for which First Union or other financial institutions act in a fiduciary or agency capacity at net asset value without a sales charge at a minimum investment of $1,000. Y Shares are not sold pursuant to a Rule 12b-1 plan. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares and Class B Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. - --------------------- SHAREHOLDER REPORTS --------------------- - --------------------- --------------------- Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (same surname, same address). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either call FUBS at 1-800-326-3241, or write the Trust. - ------------------------ ADDRESSES ------------------------ - ------------------------ ------------------------ - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor 535674 (20/pkg.) G00850-03 (2/95) FIRST UNION FLORIDA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union Florida Municipal Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [LOGO] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - ----------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 4 Restricted Securities 4 Portfolio Turnover 5 Investment Limitations 5 Florida Investment Risks 6 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 9 Trustee Compensation 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 11 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 12 Shareholder Services Plan 13 DETERMINING NET ASSET VALUE 13 - --------------------------------------------------------------- Valuing Municipal Bonds 13 Use of Amortized Cost 13 Valuing Options 13 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 14 TOTAL RETURN 14 - --------------------------------------------------------------- YIELD 14 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 15 - --------------------------------------------------------------- Tax Equivalency Table 15 PERFORMANCE COMPARISONS 18 - --------------------------------------------------------------- FINANCIAL STATEMENTS 18 - --------------------------------------------------------------- APPENDIX 19 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - ----------------------------------------------------------------------------- First Union Florida Municipal Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income which is exempt from federal regular income tax consistent with the preservation of capital. In addition, the Fund intends to qualify as an investment exempt from Florida state intangibles tax. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in a non-diversified portfolio of Florida municipal securities. PARTICIPATION INTERESTS Participation interests may take the form of participations, beneficial interests in a trust, partnership interests, or any other form of indirect ownership that allows the Fund to treat the income from the investment as exempt from federal and state tax. The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. The terms of these variable rate demand instruments require payment of principal obligations by the issuer of the participation interests or a guarantor of either issuer. All variable rate municipal securities will meet the quality standards for the Fund. The Fund's adviser has been instructed by the Trust's Board of Trustees (the "Trustees") to monitor the pricing, quality, and liquidity of the variable rate municipal securities, including participation interests held by the Fund, on the basis of published financial information and reports of the rating agencies and other analytical services. MUNICIPAL LEASES When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the Fund's adviser to consider certain factors, such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security, the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an "event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contracts. Additionally, the Fund may buy and sell call and put options on portfolio securities. The Fund does not intend to invest more than 5% of its assets in options and futures. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the realized decrease in value of the hedged securities. Alternatively, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. WRITING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS In addition to purchasing put options on futures, the Fund may write listed call options on futures contracts for U.S. government securities to hedge its portfolio against an increase in market interest rates. When the Fund writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. As market interest rates rise, causing the prices of futures to go down, the Fund's obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Fund's call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Fund keeps the premium received for the option. This premium can offset the drop in value of the Fund's fixed income portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Fund, or exercise of it by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Fund for the initial option. The net premium income of the Fund will then offset the decrease in value of the hedged securities. WRITING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may write listed put options on financial futures contracts for U.S. government securities to hedge its portfolio against a decrease in market interest rates. When the Fund writes a put option on a futures contract, it receives a premium for undertaking the obligation to assume a long futures position (buying a futures contract) at a fixed price at any time during the life of the option. As market interest rates decrease, the market price of the underlying futures contract normally increases. As the market value of the underlying futures contract increases, the buyer of the put option has less reason to exercise the put because the buyer can sell the same futures contract at a higher price in the market. The premium received by the Fund can then be used to offset the higher prices of portfolio securities to be purchased in the future due to the decrease in market interest rates. Prior to the expiration of the put option, or its exercise by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of buying the second option will be less than the premium received by the Fund for the initial option. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contract below market price. Prior to the exercise or expiration of the call option the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING AND WRITING PUT AND CALL OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put and call options on portfolio securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the writers or buyers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Fund may enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities laws. The Fund will not invest more than 15% of the value of its net assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 15% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of portfolio turnover exceeding 100%. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rates for the Fund were 72% and 3%, respectively. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of purchases and sales of securities. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in municipal bonds secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. However, the Fund may purchase put and call options on portfolio securities and on financial futures contracts. In addition, the Fund reserves the right to hedge the portfolio by entering into financial futures contracts and to sell puts and calls on financial futures contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. The Fund may, however, acquire publicly or non-publicly issued municipal bonds or temporary investments or enter into repurchase agreements in accordance with its investment objective, policies, and limitations or the Declaration of Trust. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry, or in industrial development bonds or other securities, the interest upon which is paid from revenues of similar types of projects. However, the Fund may invest as temporary investments more than 25% of the value of its assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate its assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities and municipal leases not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in industrial development bonds where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. INVESTING IN MINERALS The Fund will not purchase interests in or sell, oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund has no present intention to borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. The Fund did not invest more than 5% of its net assets in securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." FLORIDA INVESTMENT RISKS The Fund invests in obligations of Florida issuers, which results in the Fund's performance being subject to risks associated with the overall conditions present within the state. The following information is a brief summary of the recent prevailing economic conditions and a general summary of the state's financial status. This information is based on official statements relating to securities that have been offered by Florida issuers and from other sources believed to be reliable, but should not be relied upon as a complete description of all relevant information. Florida is the twenty-second largest state, with an area of 54,136 square miles and a water area of 4,424 square miles. The state is 447 miles long and 361 miles wide with a tidal shoreline of almost 2,300 miles. According to the U.S. Census Bureau, Florida moved past Illinois in 1986 to become the fourth most populous state, and as of 1990, had an estimated population of 13.2 million. Services and trade continue to be the largest components of the Florida economy, reflecting the importance of tourism as well as the need to serve Florida's rapidly growing population. Agriculture is also an important part of the economy, particularly citrus fruits. Oranges have been the principal crop, accounting for 70% of the nation's output. Manufacturing, although of less significance, is a rapidly growing component of the economy. The economy also has substantial insurance, banking, and export participation. Unemployment rates have historically been below national averages, but have recently risen above the national rate. Section 215.32 of the Florida Statutes provides that financial operations of the State of Florida covering all receipts and expenditures be maintained through the use of three funds--the General Revenue Fund, the Trust Fund and the Working Capital Fund. The General Revenue Fund receives the majority of state tax revenues. The Working Capital Fund receives revenues in excess of appropriations and its balances are freely transferred to the General Revenue Fund as necessary. In November, 1992, Florida voters approved a constitutional amendment requiring the state to fund a Budget Stabilization Fund to 5% of general revenues, with funding to be phased in over five years beginning in fiscal 1995. The Working Capital Fund will become the Budget Stabilization Fund. Major sources of tax revenues to the General Revenue Fund are the sales and use tax, corporate income tax and beverage tax. The over-dependence on the sensitive sales tax creates vulnerability to recession. Accordingly, financial operations have been strained during the past few years, but the state has responded in a timely manner to maintain budgetary control. The state is highly vulnerable to hurricane damage. Hurricane Andrew devastated portions of southern Florida in August, 1992, costing billions of dollars in emergency relief, damage, and repair costs. However, the overall financial condition of the major issuers of municipal bond debt in the state were relatively unaffected by Hurricane Andrew, due to federal disaster assistance payments and the overall level of private insurance. However, it is possible that single revenue-based local bond issues could be severely impacted by storm damage in certain circumstances. Florida's debt structure is complex. Most state debt is payable from specified taxes and additionally secured by the full faith and credit of the state. Under the general obligation pledge, to the extent specified taxes are insufficient, the state is unconditionally required to make payment on bonds from all non-dedicated taxes. The Fund's concentration in securities issued by the state and its political subdivisions provides a greater level of risk than a fund which is diversified across numerous states and municipal entities. The ability of the state or its municipalities to meet their obligations will depend on the availability of tax and other revenues; economic, political, and demographic conditions within the state; and the underlying condition of the state, and its municipalities. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank--Capital Management Group, for the exclusive benefit of the Snover Family, Charlotte, North Carolina, owned approximately 10,775.862 Shares (5.428%); and First Union National Bank, Charlotte, North Carolina, owned approximately 133,591.799 Shares (67.297%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services, for the exclusive benefit of the Lisa L. Speer Trust, Richard W. Baker, Trustee, of Holiday, Florida, owned approximately 65,000.000 Shares (6.853%). As of February 7, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ - -------------- ------------- James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $171,732 and $31,835, respectively, all of which were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund paid no commissions on transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $75,397 and $24,932, respectively, in administrative service costs, all of which were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans ") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $23,034 and $3,914, respectively, in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $178,862 and $36,011 in distribution services fees on behalf of Class B Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $19,489 for Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. USE OF AMORTIZED COST The Trustees have decided that the fair value of debt securities authorized to be purchased by the Fund with remaining maturities of 60 days or less at the time of purchase shall be their amortized cost value, unless the particular circumstances of the security indicate otherwise. Under this method, portfolio instruments and assets are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Trustees periodically assess this method of valuation and recommend changes where necessary to assure that the Fund's portfolio instruments are valued at their fair value as determined in good faith by the Trustees. VALUING OPTIONS Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the national exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS No portion of any income dividend paid by the Fund is eligible for the dividends received deductions available to corporations. CAPITAL GAINS Capital gains or losses may be realized by the Fund on the sale of portfolio securities and as a result of discounts from par value on securities held to maturity. Sales would generally be made because of: the availability of higher relative yields; differentials in market values; new investment opportunities; changes in creditworthiness of an issuer; or an attempt to preserve gains or limit losses. Distribution of long-term capital gains are taxed as such, whether they are taken in cash or reinvested, and regardless of the length of time the shareholder has owned the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total return for Class A Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 5, 1993 (start of performance) to December 31, 1994, was (13.49%) and (5.86%), respectively. The Fund's average annual total return for Class B Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 1, 1993 (start of performance) to December 31, 1994, was (14.20%) and (5.84%), respectively. Average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is compounded by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of Shares redeemed. The Fund's cumulative total return for Y Shares for the period from February 28, 1994 (start of performance) to December 31, 1994, was (6.54%). Cumulative total return reflects the Fund's total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charges, if applicable. This total return is representative of only ten months of activity since the Fund's start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Y Shares, Class A Investment Shares, and Class B Investment Shares were 6.08%, 5.55%, and 5.07%, respectively, for the thirty-day period ended December 31, 1994. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC) earned by any class of shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yields for Y Shares, Class A Investment Shares, and Class B Investment Shares for the thirty-day period ended December 31, 1994, were 8.44%, 7.71%, and 7.04%, respectively, assuming a 28% federal tax rate and 8.81%, 8.04% and 7.35%, respectively, assuming a 31% federal tax rate. The tax equivalent yield for all classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that any class would have had to earn to equal its actual yield, assuming that both the income and value of the investment are 100% taxable. TAX EQUIVALENCY TABLE TAX-EQUIVALENT YIELD TABLE FOR 1995 STATE OF FLORIDA
- ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--2.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 2.94% 21.80% 3.20% 28.00 0.00 3.47 33.76 3.77 31.00 0.00 3.62 36.25 3.94 36.00 0.00 3.91 41.12 4.25 39.60 0.00 4.14 44.43 4.50 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--3.00% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 3.53% 20.67% 3.78% 28.00 0.00 4.17 32.80 4.46 31.00 0.00 4.35 35.60 4.66 36.00 0.00 4.69 40.27 5.02 39.60 0.00 4.97 43.63 5.32 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--3.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 4.12% 19.86% 4.37% 28.00 0.00 4.86 32.11 5.16 31.00 0.00 5.07 34.94 5.38 36.00 0.00 5.47 39.66 5.80 39.60 0.00 5.79 43.05 6.15 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--4.00% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 4.71% 19.25% 4.95% 28.00 0.00 5.56 32.25 5.90 31.00 0.00 5.80 35.25 6.18 36.00 0.00 6.25 40.25 6.69 39.60 0.00 6.62 43.85 7.12 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--4.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 5.29% 18.78% 5.54% 28.00 0.00 6.25 31.20 6.54 31.00 0.00 6.52 34.07 6.83 36.00 0.00 7.03 38.84 7.36 39.60 0.00 7.45 42.28 7.80 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--5.00% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 5.88% 18.40% 6.13% 28.00 0.00 6.94 30.88 7.23 31.00 0.00 7.25 33.76 7.55 36.00 0.00 7.81 38.56 8.14 39.60 0.00 8.28 42.02 8.62 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--5.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 6.47% 18.09% 6.71% 28.00 0.00 7.64 30.62 7.93 31.00 0.00 7.97 33.51 8.27 36.00 0.00 8.59 38.33 8.92 39.60 0.00 9.11 41.80 9.45 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--6.00% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 7.06% 17.83% 7.30% 28.00 0.00 8.33 30.40 8.62 31.00 0.00 8.70 33.30 9.00 36.00 0.00 9.38 38.13 9.70 39.60 0.00 9.93 41.61 10.28 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--6.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 7.65% 17.62% 7.89% 28.00 0.00 9.03 30.22 9.31 31.00 0.00 9.42 33.12 9.72 36.00 0.00 10.16 37.97 10.48 39.60 0.00 10.76 41.46 11.10 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--7.00% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 8.24% 17.43% 8.48% 28.00 0.00 9.72 30.06 10.01 31.00 0.00 10.14 32.97 10.44 36.00 0.00 10.94 37.83 11.26 39.60 0.00 11.59 41.33 11.93 - ----------------------------------------------------------------------------------------------- TAX-FREE YIELD--7.50% - ----------------------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL STATE FEDERAL INTANGIBLES INTANGIBLES TAX INCOME TAXABLE COMBINED TAXABLE BRACKET OF TAX RATE EQUIVALENT TAX RATE EQUIVALENT - ----------------------------------------------------------------------------------------------- 15.00% 0.00% 8.82% 17.27% 9.07% 28.00 0.00 10.42 29.92 10.70 31.00 0.00 10.87 32.84 11.17 36.00 0.00 11.72 37.71 12.04 39.60 0.00 12.42 41.21 12.76
NOTE: The equivalent yields are based on a fixed $10,000 investment. Yields shown are for illustration purposes only and are not meant to represent the Fund's actual yield. * A Florida state intangibles tax on personal property after exemptions of $2.0 per $1,000 is generally imposed on the value of stocks, bonds, and other evidences of indebtedness. An example of the effect of the Florida intangibles tax on the tax brackets of Florida taxpayers is as follows. A $10,000 investment subject to the intangibles tax would require payment of $20 annually in intangibles taxes. If the investment yielded 6.5% annually or $650, the intangibles tax as a percentage of income would be $20/$650 or 3.08%. If a taxpayer were in the 31% federal income tax bracket, assuming the intangibles taxes were deducted as an itemized deduction on the shareholder's federal return, the taxpayer would be in a combined federal and Florida state tax bracket of 33.12% 31% + (1--.31) x 3.08% with respect to such investment. In order to meet its investment objective of qualifying as an investment exempt from the Florida intangibles tax, the Fund's portfolio must consist entirely of exempt securities on the last business day of the calendar year. There is no assurance that the Fund will meet this objective. If the Fund fails to meet this objective, then a shareholder should refer to the federal taxable yield equivalent column. A Florida taxpayer whose other intangible personal property is exempt or partially exempt from tax due to the availability of exemptions will have a lower taxable equivalent yield than indicated above. The above-indicated federal income tax brackets do not take into account the effect of a reduction in the deductibility of itemized deductions for taxpayers with adjusted gross income in excess of $108,450, nor the effects of phaseout of personal exemptions for single and joint filers with adjusted gross incomes in excess of $108,450 and $162,700, respectively. The effective tax brackets and equivalent taxable yields of such taxpayers will be higher than those indicated above. While it is expected that a substantial portion of the interest income distributed to the Fund's shareholders will be exempt from the regular federal income tax, portions of such distributions, from time to time, may be subject to such tax. This table does not take into account the Florida intangibles tax, state or local taxes, if any, payable on Fund distributions to individuals who are not Florida residents, or intangibles taxes, if any, imposed under the laws of other states. It should also be noted that the interest earned on certain "private activity bonds" issued after August 7, 1986, while exempt from the regular federal income tax, is treated as a tax preference item which could subject the recipient to the federal alternative minimum tax. The illustrations assume that the federal alternative minimum tax is not applicable. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC. an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS FLORIDA MUNICIPAL BOND INDEX is a total return performance benchmark for the Florida long-term, investment grade, tax-exempt bond market. Returns and attributes for this index are calculated semi-monthly using municipal bonds classified as General Obligation Bonds (state and local), Revenue Bonds (excluding insured revenue bonds), Insured Bonds (includes all bond insurers with Aaa/AAA ratings), and Prerefunded Bonds. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Florida Municipal Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Reports, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. MUNICIPAL BOND RATING DEFINITIONS Aaa--Bonds which are rated Aaa are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. Aa--Bonds which are rated Aa are judged to be of high quality by all standards. Together with the Aaa group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long term risks appear somewhat larger than in Aaa securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment some time in the future. Baa--Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. G00850-12 (2/95) 1 FIRST UNION GEORGIA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union Georgia Municipal Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 4 Restricted Securities 4 Portfolio Turnover 5 Investment Limitations 5 Georgia Investment Risks 6 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 9 Trustee Compensation 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 11 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 12 Shareholder Services Plan 12 DETERMINING NET ASSET VALUE 13 - --------------------------------------------------------------- Valuing Municipal Bonds 13 Use of Amortized Cost 13 Valuing Options 13 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 14 TOTAL RETURN 14 - --------------------------------------------------------------- YIELD 14 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 15 - --------------------------------------------------------------- Tax Equivalency Table 15 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- FINANCIAL STATEMENTS 16 - --------------------------------------------------------------- APPENDIX 17 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Georgia Municipal Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income which is exempt from federal regular income tax and Georgia state income tax consistent with preservation of capital. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in a non-diversified portfolio of Georgia municipal securities. PARTICIPATION INTERESTS Participation interests may take the form of participations, beneficial interests in a trust, partnership interests, or any other form of indirect ownership that allows the Fund to treat the income from the investment as exempt from federal and state tax. The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. The terms of these variable rate demand instruments require payment of principal obligations by the issuer of the participation interests or a guarantor of either issuer. All variable rate municipal securities will meet the quality standards for the Fund. The Fund's adviser has been instructed by the Trust's Board of Trustees (the "Trustees") to monitor the pricing, quality, and liquidity of the variable rate municipal securities, including participation interests held by the Fund, on the basis of published financial information and reports of the rating agencies and other analytical services. MUNICIPAL LEASES When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the Fund's adviser to consider certain factors, such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security, the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an "event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contracts. Additionally, the Fund may buy and sell call and put options on portfolio securities. The Fund does not intend to invest more than 5% of its assets in options and futures. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the realized decrease in value of the hedged securities. Alternatively, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. WRITING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS In addition to purchasing put options on futures, the Fund may write listed call options on futures contracts for U.S. government securities to hedge its portfolio against an increase in market interest rates. When the Fund writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. As market interest rates rise, causing the prices of futures to go down, the Fund's obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Fund's call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Fund keeps the premium received for the option. This premium can offset the drop in value of the Fund's fixed income portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Fund, or exercise of it by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Fund for the initial option. The net premium income of the Fund will then offset the decrease in value of the hedged securities. WRITING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may write listed put options on financial futures contracts for U.S. government securities to hedge its portfolio against a decrease in market interest rates. When the Fund writes a put option on a futures contract, it receives a premium for undertaking the obligation to assume a long futures position (buying a futures contract) at a fixed price at any time during the life of the option. As market interest rates decrease, the market price of the underlying futures contract normally increases. As the market value of the underlying futures contract increases, the buyer of the put option has less reason to exercise the put because the buyer can sell the same futures contract at a higher price in the market. The premium received by the Fund can then be used to offset the higher prices of portfolio securities to be purchased in the future due to the decrease in market interest rates. Prior to the expiration of the put option, or its exercise by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of buying the second option will be less than the premium received by the Fund for the initial option. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contract below market price. Prior to the exercise or expiration of the call option the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING AND WRITING PUT AND CALL OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put and call options on portfolio securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the writers or buyers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Fund may enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities laws. The Fund will not invest more than 15% of the value of its net assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 15% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non- exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of portfolio turnover exceeding 100%. For the fiscal year ended December 31, 1994 and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rates for the Fund were 147% and 15%, respectively. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of purchases and sales of securities. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in municipal bonds secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. However, the Fund may purchase put and call options on portfolio securities and on financial futures contracts. In addition, the Fund reserves the right to hedge the portfolio by entering into financial futures contracts and to sell puts and calls on financial futures contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. The Fund may, however, acquire publicly or non-publicly issued municipal bonds or temporary investments or enter into repurchase agreements in accordance with its investment objective, policies, and limitations or the Declaration of Trust. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry, or in industrial development bonds or other securities, the interest upon which is paid from revenues of similar types of projects. However, the Fund may invest as temporary investments more than 25% of the value of its assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate its assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities and municipal leases not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in industrial development bonds where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. INVESTING IN MINERALS The Fund will not purchase interests in or sell, oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund has no present intention to borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. The Fund did not invest more than 5% of its net assets in securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." GEORGIA INVESTMENT RISKS Because the Fund will ordinarily invest 80% or more of its net assets in Georgia obligations, it is more susceptible to factors affecting Georgia issuers than is a comparable municipal bond fund not concentrated in the obligations of issuers located in a single state. Georgia's rating reflects the state's positive economic trends, conservative financial management, improved financial position, and low debt burden. The state's recovery from the recent economic recession has been steady; the rate of recovery is better than regional trends, albeit half the rate of earlier recoveries. While this recovery does not meet the explosive patterns set in past cycles, recent state data reveal that Georgia ranks among the top five states in the nation in employment and total population growth. Stronger economic trends and conservative revenue forecasting resulted in the continuation of improved financial results for the fiscal year ended June 30, 1994. The state's general fund closed fiscal 1994 with a total fund balance position of $480.6 million, of which $249.5 million was in the revenue shortfall reserve fund (3% of revenues), marking the second consecutive year of build-up in that reserve. The mid-year adjustment reserve was fully funded at $89.1 million. The state's adopted budget fiscal 1995 called for an increase in state spending to $9.8 billion, up 6.5% from the prior period. Estimating that economic growth will be in the 6%-8% range for the second straight year, the budget report forecasted general fund revenues to grow to $9.4 billion, an increase of $490.0 million, or 5.5% above actual fiscal 1994 levels. Sales and income taxes account for the majority of that increase, despite a $100 million cut in personal income taxes. Additional revenues provided by lottery proceeds ($240 million) and indigent-care trust fund monies support the remaining spending. Revenues for the first three months of the current year are running nearly 8.4% above fiscal 1994 levels. Most of the increase is attributable to the growth in personal and corporate income and sales taxes. As a result, the state anticipates that fiscal 1995 will once again produce positive financial results. Except for the major building projects necessary for the 1996 Summer Olympics, it appears unlikely that areas in and around metropolitan Atlanta will experience the building construction rates of the mid to late 1980's. It further appears that many of Georgia's other cities are poised to participate in the recovery that inevitably will take place. The classification of the Fund under the Investment Company Act of 1940 as a "non-diversified" investment company allows the Fund to invest more than 5% of its assets in the securities of any issuer, subject to satisfaction of certain tax requirements. Because of the relatively small number of issues of Georgia obligations, the Fund is likely to invest a greater percentage of its assets in the securities of a single issuer than is an investment company which invests in a broad range of municipal obligations. Therefore, the Fund would be more susceptible than a diversified investment company to any single adverse economic or political occurrence or development affecting Georgia issuers. The Fund will also be subject to an increased risk of loss if the issuer is unable to make interest or principal payments or if the market value of such securities declines. It is also possible that there will not be sufficient availability of suitable Georgia tax-exempt obligations for the Fund to achieve its objective of providing income exempt from Georgia income tax. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank, Charlotte, North Carolina, owned approximately 132,561.656 Shares (99.934%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services ("FUBS"), for the exclusive benefit of Mrs. Ralph Marlet of Powder Springs, Georgia, owned approximately 12,793.177 Shares (7.959%); FUBS, for the exclusive benefit of Felix Wright, Jr. of Augusta, Georiga, owned approximately 8,122.559 Shares (5.053%); and FUBS, for the exclusive benefit of Jack Loos and Viola Loos of Martinez, Georgia, owned approximately 9,463.308 Shares (5.887%). As of February 7, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection - -------------------------------------------------------------------------------- of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $36,674 and $5,416, respectively, all of which were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund paid no commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $75,479 and $24,931, respectively, in administrative service costs, all of which were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: . quantity discounts and accumulated purchases; . signing a 13-month letter of intent; . using the reinvestment privilege; or . concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $3,045 in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $44,866 in distribution services fees on behalf of Class B Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $5,407 for Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. USE OF AMORTIZED COST The Trustees have decided that the fair value of debt securities authorized to be purchased by the Fund with remaining maturities of 60 days or less at the time of purchase shall be their amortized cost value, unless the particular circumstances of the security indicate otherwise. Under this method, portfolio instruments and assets are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Trustees periodically assess this method of valuation and recommend changes where necessary to assure that the Fund's portfolio instruments are valued at their fair value as determined in good faith by the Trustees. VALUING OPTIONS Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the national exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS No portion of any income dividend paid by the Fund is eligible for the dividends received deductions available to corporations. CAPITAL GAINS Capital gains or losses may be realized by the Fund on the sale of portfolio securities and as a result of discounts from par value on securities held to maturity. Sales would generally be made because of: . the availability of higher relative yields; . differentials in market values; . new investment opportunities; . changes in creditworthiness of an issuer; or . an attempt to preserve gains or limit losses. Distribution of long-term capital gains are taxed as such, whether they are taken in cash or reinvested, and regardless of the length of time the shareholder has owned the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total return for Class A Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 1, 1993 (start of performance) to December 31, 1994, was (13.94%) and (7.16%), respectively. The Fund's average annual total return for Class B Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 1, 1993 (start of performance) to December 31, 1994, was (14.66%) and (7.15%), respectively. Average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is compounded by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of shares redeemed. The Fund's cumulative total return for Y Shares for the period from February 28, 1994 (start of performance) to December 31, 1994, was (6.87%). Cumulative total return reflects the Fund's total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. This total return is representative of only 6 months of activity since the Fund's effective date. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Y Shares, Class A Investment Shares, and Class B Investment Shares were 6.45%, 5.90%, and 5.46%, respectively, for the thirty-day period ended December 31, 1994. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by any class of shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yields for Y Shares, Class A Investment Shares, and Class B Investment Shares for the thirty-day period ended December 31, 1994 , were 9.77%, 8.94% and 8.27%%, respectively assuming a 28% federal tax rate. The tax equivalent yield for all classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that any class would have had to earn to equal its actual yield, assuming a 28% federal tax rate and the 6.00% regular personal income tax rate imposed by Georgia, and assuming that income earned by the Fund is 100% tax-exempt on a regular federal, state, and local basis. TAX EQUIVALENCY TABLE Each class of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the portfolio generally remains free from federal regular income tax,* and is often free from state and local taxes as well. As the table below indicates, a "tax free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields. TAXABLE YIELD EQUIVALENT FOR 1995 STATE OF GEORGIA - ------------------------------------------------------------------------------
TAX BRACKET: FEDERAL 15.00% 28.00% 31.00% 36.00% 39.60% COMBINED FEDERAL AND STATE 22.00% 34.00% 37.00% 42.00% 45.60% - ------------------------------------------------------------------------------ JOINT $1- $39,001- $94,251- $143,601- Over RETURN: 39,000 94,250 143,600 256,500 $ 256,500 SINGLE $1- $23,351- $56,551- $117,951- Over RETURN: 23,350 56,550 117,950 256,500 $ 256,500 - ------------------------------------------------------------------------------
TAX-EXEMPT YIELD
TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------ 1.50% 1.90% 2.27% 2.38% 2.59% 2.76% 2.00 2.53 3.03 3.17 3.45 3.68 2.50 3.16 3.79 3.97 4.31 4.60 3.00 3.80 4.55 4.76 5.17 5.51 3.50 4.43 5.30 5.56 6.03 6.43 4.00 5.06 6.06 6.35 6.90 7.35 4.50 5.70 6.82 7.14 7.76 8.27 5.00 6.33 7.58 7.94 8.62 9.19 5.50 6.96 8.33 8.73 9.48 10.11 6.00 7.59 9.09 9.52 10.34 11.03 6.50 8.23 9.85 10.32 11.21 11.95 7.00 8.86 10.61 11.11 12.07 12.87
Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. Furthermore, additional state and local taxes paid on comparable taxable investments were not used to increase federal deductions. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of any class of Shares. *Some portion of each class's income may be subject to the federal alternative minimum tax and state and local taxes. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC. an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS GEORGIA MUNICIPAL BOND INDEX is a total return performance benchmark for the Georgia long-term, investment grade, tax-exempt bond market. Returns and attributes for this index are calculated semi-monthly using municipal bonds classified as General Obligation Bonds (state and local), Revenue Bonds (excluding insured revenue bonds), Insured Bonds (includes all bond insurers with Aaa/AAA ratings), and Prerefunded Bonds. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non- standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Georgia Municipal Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. MUNICIPAL BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment some time in the future. BAA--Bonds which are rated BAA are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. G00850-26 (2/95) FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union North Carolina Municipal Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 4 Restricted Securities 4 Portfolio Turnover 5 Investment Limitations 5 North Carolina Investment Risks 6 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 9 Trustee Compensation 10 Trustee Liability 10 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 11 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 11 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 12 Shareholder Services Plan 13 DETERMINING NET ASSET VALUE 13 - --------------------------------------------------------------- Valuing Municipal Bonds 13 Use of Amortized Cost 13 Valuing Options 13 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 14 TAX STATUS 14 - --------------------------------------------------------------- The Fund's Tax Status 14 Shareholders' Tax Status 14 TOTAL RETURN 14 - --------------------------------------------------------------- YIELD 15 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 15 - --------------------------------------------------------------- Tax Equivalency Table 15 PERFORMANCE COMPARISONS 16 - --------------------------------------------------------------- FINANCIAL STATEMENTS 17 - --------------------------------------------------------------- APPENDIX 18 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union North Carolina Municipal Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares, and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income which is exempt from federal regular income tax and North Carolina state income tax consistent with preservation of capital. In addition, the Fund intends to qualify as an investment substantially exempt from the North Carolina intangible personal property tax. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in a non-diversified portfolio of North Carolina municipal securities. PARTICIPATION INTERESTS Participation interests may take the form of participations, beneficial interests, in a trust, partnership interests, or any other form of indirect ownership that allows the Fund to treat the income from the investment as exempt from federal and state tax. The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. The terms of these variable rate demand instruments require payment of principal obligations by the issuer of the participation interests or a guarantor of either issuer. All variable rate municipal securities will meet the quality standards for the Fund. The Fund's adviser has been instructed by the Trust's Board of Trustees (the "Trustees") to monitor the pricing, quality, and liquidity of the variable rate municipal securities, including participation interests held by the Fund, on the basis of published financial information and reports of the rating agencies and other analytical services. MUNICIPAL LEASES When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the Fund's adviser to consider certain factors, such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security, the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an "event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. FUTURES AND OPTIONS TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contracts. Additionally, the Fund may buy and sell call and put options on portfolio securities. The Fund does not intend to invest more than 5% of its assets in options and futures. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the realized decrease in value of the hedged securities. Alternatively, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. WRITING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS In addition to purchasing put options on futures, the Fund may write listed call options on futures contracts for U.S. government securities to hedge its portfolio against an increase in market interest rates. When the Fund writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. As market interest rates rise, causing the prices of futures to go down, the Fund's obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Fund's call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Fund keeps the premium received for the option. This premium can offset the drop in value of the Fund's fixed income portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Fund, or exercise of it by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Fund for the initial option. The net premium income of the Fund will then offset the decrease in value of the hedged securities. WRITING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may write listed put options on financial futures contracts for U.S. government securities to hedge its portfolio against a decrease in market interest rates. When the Fund writes a put option on a futures contract, it receives a premium for undertaking the obligation to assume a long futures position (buying a futures contract) at a fixed price at any time during the life of the option. As market interest rates decrease, the market price of the underlying futures contract normally increases. As the market value of the underlying futures contract increases, the buyer of the put option has less reason to exercise the put because the buyer can sell the same futures contract at a higher price in the market. The premium received by the Fund can then be used to offset the higher prices of portfolio securities to be purchased in the future due to the decrease in market interest rates. Prior to the expiration of the put option, or its exercise by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of buying the second option will be less than the premium received by the Fund for the initial option. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contract below market price. Prior to the exercise or expiration of the call option the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING AND WRITING PUT AND CALL OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put and call options on portfolio securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the writers or buyers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Fund may enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities laws. The Fund will not invest more than 15% of the value of its net assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 15% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of portfolio turnover exceeding 100%. For the fiscal year ended December 31, 1994 and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rates for the Fund were 126% and 57%, respectively. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of purchases and sales of securities. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in municipal bonds secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. However, the Fund may purchase put and call options on portfolio securities and on financial futures contracts. In addition, the Fund reserves the right to hedge the portfolio by entering into financial futures contracts and to sell puts and calls on financial futures contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. The Fund may, however, acquire publicly or non-publicly issued municipal bonds or temporary investments or enter into repurchase agreements in accordance with its investment objective, policies, and limitations or the Declaration of Trust. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry, or in industrial development bonds or other securities, the interest upon which is paid from revenues of similar types of projects. However, the Fund may invest as temporary investments more than 25% of the value of its assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate its assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities and municipal leases not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in industrial development bonds where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. INVESTING IN MINERALS The Fund will not purchase interests in or sell, oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund has no present intention to borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. The Fund did not invest more than 5% of its net assets in securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." NORTH CAROLINA INVESTMENT RISKS Because the Fund will ordinarily invest 80% or more of its net assets in North Carolina obligations, it is more susceptible to factors affecting North Carolina (or the "State") issuers than is a comparable municipal bond fund not concentrated in the obligations of issuers located in a single state. North Carolina has an economy dependent on manufacturing and agriculture; however, diversification into trade and service areas is occurring. Historically, textiles and furniture dominated industry lines, but increased activity in financial services, research, and high technology manufacturing is now apparent. Tobacco remains the primary agricultural commodity. Economic development continues, and long-term personal income trends indicate gains, although wealth levels remain below those of the nation. Employment growth accelerated over the past two years, and unemployment rates remain below those of the nation. North Carolina is characterized by moderate debt levels (albeit with growing capital needs), favorable economic performance, and financial strengths exhibited over the past several years. North Carolina is one of only several states expected to sustain favorable economic expansion throughout the 1990's, according to the U.S. Bureau of Economic Analysis indicators. Economic growth in the State is bolstered by a lower-than-average cost of living, income levels at about 90% of U.S. averages--though it is much higher in the metropolitan centers--and a highly respected public and private higher education system, including the University of North Carolina at Chapel Hill and Duke University in Durham. The North Carolina State Constitution requires that the total expenditures of the State for a fiscal period shall not exceed the total of receipts during the fiscal period and the surplus remaining in the State Treasury at the beginning of the period. In certain of the past several years, the State has had to restrict expenditures to comply with the State Constitution. The State has a long record of sound financial operations, and while the revenue system is narrow, the budget balancing law is strong and appropriate curbs are made when necessary. The state's finances, which enjoyed surpluses and adequate reserves throughout the 1980s, began reflecting economic downturn in fiscal 1990. Reserves were fully depleted during the recession, but through a combination of tax and spending actions and more recently, with the aid of economic recovery, have now been fully restored. Financial operations have been restored to their historically healthy position after a period of strain between fiscal years 1990 and 1992. Available unreserved balances and budget stabilization reserve totaled $440 million at the end of fiscal 1994--equivalent to 4.1% of annual expenditures. On a budgetary basis, fiscal 1994 ended with an $887.5 million balance; however, a portion of this balance has been appropriated for fiscal 1995 operations. Conservative revenue assumptions and sound budgeting practices should result in a similar balance at the end of 1995. The restoration of adequate reserve levels confirms the state's longstanding commitment to a sound financial position. Debt ratios are among the lowest in the country. State debt ratios will remain below national medians even after all of the $300 million of currently authorized debt is issued. Payout is rapid. North Carolina ranks among the top ten states in terms of economic growth, as measured by job and personal income growth. Diversification into financial services, research, and high technology manufacturing is reducing historical dependence on agriculture, textiles, and furniture manufacturing. As of December 31, 1994, general obligations of the State of North Carolina were rated Aaa/AAA/AAA by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Group ("S&P") and Fitch Investors Service ("Fitch"), respectively. There can be no assurance that the economic conditions on which these ratings are based will continue or that particular bond issues may not be adversely affected by changes in economic, political or other conditions. North Carolina obligations also include obligations of the governments of Puerto Rico, the Virgin Islands and Guam to the extent these obligations are exempt from North Carolina State personal income taxes. The Fund will not invest more than 5% of its net assets in the obligations of each of the Virgin Islands and Guam, but may invest without limitation in the obligations of Puerto Rico. Accordingly, the Fund may be adversely affected by local political and economic conditions and developments within Puerto Rico affecting the issuers of such obligations. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp. and Passport Research Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank--Capital Management Group ("First Union-CMG"), for the exclusive benefit of Gene B. and Kay Thompson, Charlotte, North Carolina, owned approximately 4,441.536 Shares (6.742%); First Union-CMG, for the exclusive benefit of Margaret C. James, Charlotte, North Carolina, owned approximately 5,457.872 Shares (8.284%); First Union-CMG, for the exclusive benefit of Robert Barnes, Charlotte, North Carolina, owned approximately 4,279.176 Shares (6.496%); First Union-CMG, for the exclusive benefit of Chris Vlahos, Charlotte, North Carolina, owned approximately 4,680.242 Shares (7.105%); First Union-CMG, for the exclusive benefit of Pauline Waller, Charlotte, North Carolina, owned approximately 10,884.861 Shares (16.525%); First Union-CMG, for the exclusive benefit of James R. and Elizabeth W. Pearson, Charlotte, North Carolina, owned approximately 5,373.872 Shares (8.158%); First Union-CMG, for the exclusive benefit of James O. Woodward, Charlotte, North Carolina, owned approximately 6,972.304 Shares (10.584%); First Union-CMG, for the exclusive benefit of William A. Joyner, Charlotte, North Carolina, owned approximately 3,825.319 Shares (5.807%); First Union-CMG, for the exclusive benefit of Dorothy Henry, Charlotte, North Carolina, owned approximately 4,128.000 Shares (6.266%); and First Union National Bank, Charlotte, North Carolina, owned approximately 10,783.524 Shares (16.370%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services ("FUBS"), for the exclusive benefit of the Mary M. Lipinsky Trust, Louis H. Lipinsky, Jr. and Mary H. Lipinsky, Trustees, of Ashville, North Carolina, owned approximately 53,294.574 Shares (6.047%); and FUBS, for the exclusive benefit of Marie M. Newton of Patterson, North Carolina, owned approximately 46,685.341 Shares (5.297%). As of February 7, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. - -------------------------------------------------------------------------------- TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected 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 his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $287,040 and $170,496, respectively, of which $193,158 and $170,496 were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund paid $1,250 and $0, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $75,476 and $48,493, respectively, in administrative service costs, of which $28,121 and $48,493 were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $24,761 and $19,395, respectively, in distribution services fees on behalf of Class A Investment Shares, of which $0 and $1,923 were voluntarily waived. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $353,880 and $197,522, respectively, in distribution services fees on behalf of Class B Investment Shares, of which $0 and $13,415 were voluntarily waived. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $35,677 for Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. USE OF AMORTIZED COST The Trustees have decided that the fair value of debt securities authorized to be purchased by the Fund with remaining maturities of 60 days or less at the time of purchase shall be their amortized cost value, unless the particular circumstances of the security indicate otherwise. Under this method, portfolio instruments and assets are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Trustees periodically assess this method of valuation and recommend changes where necessary to assure that the Fund's portfolio instruments are valued at their fair value as determined in good faith by the Trustees. VALUING OPTIONS Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the national exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS No portion of any income dividend paid by the Fund is eligible for the dividends received deduction available to corporations. CAPITAL GAINS Capital gains or losses may be realized by the Fund on the sale of portfolio securities and as a result of discounts from par value on securities held to maturity. Sales would generally be made because of: . the availability of higher relative yields; . differentials in market values; . new investment opportunities; . changes in creditworthiness of an issuer; or . an attempt to preserve gains or limit losses. Distribution of long-term capital gains are taxed as such, whether they are taken in cash or reinvested, and regardless of the length of time the shareholder has owned the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total return for Class A Investment Shares for the fiscal year ended December 31, 1994, and for the period from January 12, 1993 (start of performance) to December 31, 1994, was (13.44%) and (1.89%), respectively. The Fund's average annual total return for Class B Investment Shares for the fiscal year ended December 31, 1994, and for the period from January 12, 1993 (start of performance) to December 31, 1994, was (14.16%) and (2.01%), respectively. Average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is compounded by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price of the net asset value of Shares redeemed. The Fund's cumulative total return for Y Shares for the period from February 28, 1994 (start of performance) to December 31, 1994, was (7.03%). Cumulative total return reflects the Fund's total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. This total return is representative of only 10 months of activity since the Fund's start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Y Shares, Class A Investment Shares, and Class B Investment Shares were 5.96%, 5.43%, and 4.96%, respectively, for the thirty-day period ended December 31, 1994. The yield for all classes of shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC), earned by any class of Shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yields for Y Shares, Class A Investment Shares, and Class B Investment Shares for the thirty-day period ended December 31, 1994, were 8.28%, 7.54%, and 6.89%, respectively, assuming a combined federal and state tax rate of 28%. The tax equivalent yield for all classes of shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that any class would have had to earn to equal its actual yield, assuming that income is 100% tax- exempt. TAX EQUIVALENCY TABLE Each class of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the portfolio generally remains free from federal regular income tax,* and is often free from state and local taxes as well. As the table below indicates, a "tax free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields.
- -------------------------------------------------------------------------------- TAXABLE YIELD EQUIVALENT FOR 1995 STATE OF NORTH CAROLINA - ------------------------------------------------------------------------------------------ TAX BRACKET: FEDERAL 15.00% 28.00% 31.00% 31.00% 36.00% 39.60% COMBINED FEDERAL AND STATE 22.00% 35.00% 38.00% 38.75% 43.75% 47.35% - ------------------------------------------------------------------------------------------ JOINT $1- $39,001- $94,251- $100,001- $143,601- Over RETURN: 39,000 94,250 100,000 143,600 256,500 $ 256,500 SINGLE $1- $23,351- $56,551- $60,001- $117,951- Over RETURN: 23,350 56,550 60,000 117,950 256,500 $ 256,500 - ------------------------------------------------------------------------------------------ TAX-EXEMPT YIELD TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------------------ 3.50% 4.49% 5.38% 5.65% 5.71% 6.22% 6.65% 4.00 5.13 6.15 6.45 6.53 7.11 7.60 4.50 5.77 6.92 7.26 7.35 8.00 8.55 5.00 6.41 7.69 8.06 8.16 8.89 9.50 5.50 7.05 8.46 8.87 8.98 9.78 10.45 6.00 7.69 9.23 9.68 9.80 10.67 11.40 6.50 8.33 10.00 10.48 10.61 11.56 12.35 7.00 8.97 10.77 11.29 11.43 12.44 13.30 7.50 9.62 11.54 12.10 12.24 13.33 14.25 8.00 10.26 12.31 12.90 13.06 14.22 15.19
Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. Furthermore, additional state and local taxes paid on comparable taxable investments were not used to increase federal deductions. North Carolina residents and North Carolina corporations may exclude from the share value of the North Carolina Municipal Bond Portfolio, for the purposes of the North Carolina intangible personal property tax, that portion of the total share value which is attributable to the value of the direct obligations of the State of North Carolina, of the United States, and of their political subdivisions held in the Fund as of December 31 of the taxable year. The North Carolina Municipal Bond Portfolio will annually furnish to its shareholders a statement supporting the proper allocation. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of any class of Shares. *Some portion of each class's income may be subject to the federal alternative minimum tax and state and local taxes. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC. an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS GENERAL OBLIGATION MUNICIPAL BOND INDEX is comprised of state general obligation debt issues. These bonds are rated A or better and represent a variety of coupon ranges. Index figures are total returns calculated for one, three, and twelve month periods as well as year-to-date. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union North Carolina Municipal Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATING GROUP MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Rating Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. MUNICIPAL BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment some time in the future. BAA--Bonds which are rated BAA are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. G00850-19 (2/95) FIRST UNION SOUTH CAROLINA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union South Carolina Municipal Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 4 Restricted Securities 4 Portfolio Turnover 5 Investment Limitations 5 South Carolina Investment Risks 6 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 9 Trustee Compensation 9 Trustee Liability 10 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 11 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 12 Shareholder Services Plan 12 DETERMINING NET ASSET VALUE 13 - --------------------------------------------------------------- Valuing Municipal Bonds 13 Use of Amortized Cost 13 Valuing Options 13 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 14 TOTAL RETURN 14 - --------------------------------------------------------------- YIELD 14 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 15 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- FINANCIAL STATEMENTS 16 - --------------------------------------------------------------- APPENDIX 17 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union South Carolina Municipal Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income which is exempt from federal regular income tax and South Carolina state income tax consistent with the preservation of capital. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in a non-diversified portfolio of South Carolina municipal securities. PARTICIPATION INTERESTS Participation interests may take the form of participations, beneficial interests in a trust, partnership interests, or any other form of indirect ownership that allows the Fund to treat the income from the investment as exempt from federal and state tax. The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. The terms of these variable rate demand instruments require payment of principal obligations by the issuer of the participation interests or a guarantor of either issuer. All variable rate municipal securities will meet the quality standards for the Fund. The Fund's adviser has been instructed by the Trust's Board of Trustees (the "Trustees") to monitor the pricing, quality, and liquidity of the variable rate municipal securities, including participation interests held by the Fund, on the basis of published financial information and reports of the rating agencies and other analytical services. MUNICIPAL LEASES When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the Fund's adviser to consider certain factors, such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security, the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an "event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contracts. Additionally, the Fund may buy and sell call and put options on portfolio securities. The Fund does not intend to invest more than 5% of its assets in options and futures. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the realized decrease in value of the hedged securities. Alternatively, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. WRITING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS In addition to purchasing put options on futures, the Fund may write listed call options on futures contracts for U.S. government securities to hedge its portfolio against an increase in market interest rates. When the Fund writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. As market interest rates rise, causing the prices of futures to go down, the Fund's obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Fund's call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Fund keeps the premium received for the option. This premium can offset the drop in value of the Fund's fixed income portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Fund, or exercise of it by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Fund for the initial option. The net premium income of the Fund will then offset the decrease in value of the hedged securities. WRITING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may write listed put options on financial futures contracts for U.S. government securities to hedge its portfolio against a decrease in market interest rates. When the Fund writes a put option on a futures contract, it receives a premium for undertaking the obligation to assume a long futures position (buying a futures contract) at a fixed price at any time during the life of the option. As market interest rates decrease, the market price of the underlying futures contract normally increases. As the market value of the underlying futures contract increases, the buyer of the put option has less reason to exercise the put because the buyer can sell the same futures contract at a higher price in the market. The premium received by the Fund can then be used to offset the higher prices of portfolio securities to be purchased in the future due to the decrease in market interest rates. Prior to the expiration of the put option, or its exercise by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of buying the second option will be less than the premium received by the Fund for the initial option. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contract below market price. Prior to the exercise or expiration of the call option the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING AND WRITING PUT AND CALL OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put and call options on portfolio securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the writers or buyers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Fund may enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities laws. The Fund will not invest more than 15% of the value of its net assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 15% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of portfolio turnover exceeding 100%. For the period from January 3, 1994 (commencement of operations) to December 31, 1994, the portfolio turnover rate for the Fund was 23%. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of purchases and sales of securities. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate its assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in municipal bonds secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. However, the Fund may purchase put and call options on portfolio securities and on financial futures contracts. In addition, the Fund reserves the right to hedge the portfolio by entering into financial futures contracts and to sell puts and calls on financial futures contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. The Fund may, however, acquire publicly or non-publicly issued municipal bonds or temporary investments or enter into repurchase agreements in accordance with its investment objective, policies, and limitations or the Declaration of Trust. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry, or in industrial development bonds or other securities, the interest upon which is paid from revenues of similar types of projects. However, the Fund may invest as temporary investments more than 25% of the value of its assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities and municipal leases not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in industrial development bonds where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. INVESTING IN MINERALS The Fund will not purchase interests in or sell, oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund has no present intention to borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. The Fund did not invest more than 5% of its net assets in securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items". SOUTH CAROLINA INVESTMENT RISKS The State of South Carolina has an economy dominated from the early 1920's to the present by the textile industry, with over one of every three manufacturing workers directly or indirectly related to the textile industry. However, since 1950 the economic bases of the State have become more diversified, as the trade and service sectors and durable goods manufacturing industries have developed. Currently, Moody's Investors Service, Inc. ("Moody's") rates South Carolina general obligation bonds "Aaa" and Standard & Poor's Ratings Group ("S&P") rates such bonds "AA+." There can be no assurance that the economic conditions on which those ratings are based will continue or that particular bond issues may not be adversely affected by changes in economic or political conditions. The South Carolina State Constitution mandates a balanced budget. If a deficit occurs, the General Assembly must account for it in the succeeding fiscal year. In addition, if a deficit appears likely, the State Budget and Control Board (the "State Board") may reduce appropriations during the current fiscal year as necessary to prevent the deficit. The State Constitution limits annual increases in State appropriations to the average growth rate of the economy of the State and annual increases in the number of State employees to the average growth of the population of the State. The State Constitution requires a General Reserve Fund ("General Fund") that equals three percent of General Fund revenue for the latest fiscal year. When deficits have occurred, the State has funded them out of the General Fund. The State Constitution also requires a Capital Reserve Fund ("Capital Fund") equal to two percent of General Fund revenue. Before March 1st of each year, the Capital Fund must be used to offset mid-year budget reductions before mandating cuts in operating appropriations, and after March 1st, the Capital Fund may be appropriated by a special vote of the General Assembly to finance previously authorized capital improvement bond projects, to retire bond principal or pay interest on bonds previously issued, and to pay for capital improvements or other nonrecurring purposes. Monies in the Capital Fund not appropriated or any appropriation for a particular project or item that has been reduced due to application of the monies to a year-end deficit must go back to the General Fund. The effects of the most recent military base-closing and consolidation legislation is having a negative effect on several sections of the State, particularly the Charleston area. During 1995, the Charleston Naval Base and Shipyard will begin closing down. The Navy has estimated that up to 38,000 jobs will be lost over the next several years. The Fund's concentration in securities issued by the State or its subdivisions provides a greater level of risk than an investment company which is diversified across a larger geographic area. For example, the passage of the North American Free Trade Agreement could result in increased competition for the State's textile industry due to the availability of less-expensive foreign labor. Presently, South Carolina subjects bonds issued by other states to its income tax. If this tax was declared unconstitutional, the value of bonds in the Fund could decline a small but measurable amount. Also, the Fund could become slightly less attractive to potential future investors. The Fund's investment adviser believes that the information summarized above describes some of the more significant matters relating to the Fund. The sources of the information are the official statements of issuers located in South Carolina, other publicly available documents, and oral statements from various State agencies. The Fund's investment adviser has not independently verified any of the information contained in the official statement, other publicly available documents, or oral statements from various State agencies. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research; Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank--Capital Management Group ("First Union-CMG"), for the exclusive benefit of Lawrence and Jean Farry, Charlotte, North Carolina, owned approximately 6,314.849 Shares (25.639%); First Union-CMG, for the exclusive benefit of Marge Barnwell, Charlotte, North Carolina, owned approximately 4,436.418 Shares (18.012%); and First Union National Bank, Charlotte, North Carolina, owned approximately 13,856.813 Shares (56.260%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services ("FUBS"), for the exclusive benefit of Robert Allen Jones and Larry Allen Jones of Florence, South Carolina, owned approximately 2,642.684 Shares (7.241%); FUBS, for the exclusive benefit of Carolyn E. Bickler of Columbia, South Carolina, owned approximately 3,139.631 Shares (8.603%); FUBS, for the exclusive benefit of Thomas B. Carr and Louise B. Carr of Wylie, South Carolina, owned approximately 16,326.787 Shares (44.738%); and FUBS, for the exclusive benefit of Mildred R. Robards, of Rock Hill, South Carolina, owned approximately 5,464.481 Shares (14.973%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: FUBS, for the exclusive benefit of Ruby Motsinger, Joseph Glenn Motsinger, Melvin L. Motsinger and Hilda M. Thompson of Clover, South Carolina, owned approximately 22,905.386 Shares (7.918%). TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the Fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the period from January 3, 1994 (commencement of operations) to December 31, 1994, the Adviser earned advisory fees of $8,905, all of which was voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the period from January 4, 1994 (commencement of operations) to December 31, 1994, the Fund paid no commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the period from January 3, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $104,356 in administrative service costs, all of which was waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: . quantity discounts and accumulated purchases; . signing a 13-month letter of intent; . using the reinvestment privilege; or . concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the period from January 3, 1994 (commencement of operations) to December 31, 1994, the Fund incurred $393 and $11,793 in distribution services fees for Class A Investment Shares and Class B Investment Shares, respectively. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $1,833 for Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. USE OF AMORTIZED COST The Trustees have decided that the fair value of debt securities authorized to be purchased by the Fund with remaining maturities of 60 days or less at the time of purchase shall be their amortized cost value, unless the particular circumstances of the security indicate otherwise. Under this method, portfolio instruments and assets are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Trustees periodically assess this method of valuation and recommend changes where necessary to assure that the Fund's portfolio instruments are valued at their fair value as determined in good faith by the Trustees. VALUING OPTIONS Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the national exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS No portion of any income dividend paid by the Fund is eligible for the dividends received deduction available to corporations. CAPITAL GAINS Capital gains or losses may be realized by the Fund on the sale of portfolio securities and as a result of discounts from par value on securities held to maturity. Sales would generally be made because of: . the availability of higher relative yields; . differentials in market values; . new investment opportunities; . changes in creditworthiness of an issuer; or . an attempt to preserve gains or limit losses. Distribution of long-term capital gains are taxed as such, whether they are taken in cash or reinvested, and regardless of the length of time the shareholder has owned the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's cumulative total returns for Class A Investment Shares and Class B Investment Shares from January 3, 1994 (start of performance) to December 31, 1994, were (13.64%) and (14.31%), respectively. Average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is compounded by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of Shares redeemed. The Fund's cumulative total return for Y Shares from February 28, 1994 (start of performance) to December 31, 1994, was (7.14%). Cumulative total return reflects the Fund's total performance over a specified period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. The Fund's total return for Class A Investment Shares and Class B Investment Shares is representative of only 11 months of investment activity since the Fund's start of performance. The Fund's total return for Y Shares is representative of only 10 months of Fund activity since the Fund's start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Y Shares, Class A Investment Shares, and Class B Investment Shares were 6.53%, 5.97%, and 5.52%, respectively, for the thirty-day period ended December 31, 1994. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC) earned by any class of shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yields for Y Shares Class A Investment Shares, and Class B Investment Shares for the thirty-day period ended December 31, 1994, were 10.05%, 9.18%, and 8.49%, respectively, assuming a combined state and federal tax rate of 35%. The tax equivalent yield for all classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that any class would have had to earn to equal its actual yield, assuming that income is 100% tax- exempt. TAX EQUIVALENCY TABLE Each class of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the portfolio generally remains free from federal regular income tax,* and is often free from state and local taxes as well. As the table below indicates, a "tax free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields.
TAXABLE YIELD EQUIVALENT FOR 1995 STATE OF SOUTH CAROLINA - ------------------------------------------------------------------------------- COMBINED FEDERAL AND STATE INCOME TAX BRACKET: 22.00% 35.00% 38.00% 43.00% 46.60% - ------------------------------------------------------------------------------- JOINT $1- $39,001- $94,251 $143,601 Over RETURN: 39,000 94,250 143,600 256,500 $ 256,500 SINGLE $1- $23,351- $56,551- $117,951- Over RETURN: 23,350 56,550 117,950 256,500 $ 256,500 - ------------------------------------------------------------------------------- TAX-EXEMPT YIELD TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------- 2.50% 3.21% 3.85% 4.03% 4.39% 4.68% 3.00 3.85 4.62 4.84 5.26 5.62 3.50 4.49 5.38 5.65 6.14 6.55 4.00 5.13 6.15 6.45 7.02 7.49 4.50 5.77 6.92 7.26 7.89 8.43 5.00 6.41 7.69 8.06 8.77 9.36 5.50 7.05 8.46 8.87 9.65 10.30 6.00 7.69 9.23 9.68 10.53 11.24 6.50 8.33 10.00 10.48 11.40 12.17 7.00 8.97 10.77 11.29 12.28 13.11
Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. Furthermore, additional state and local taxes paid on comparable taxable investments were not used to increase federal deductions. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of any class of Shares. *Some portion of each class's income may be subject to the federal alternative minimum tax and state and local taxes. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC. an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS SOUTH CAROLINA MUNICIPAL BOND INDEX is a total return performance benchmark for the South Carolina long-term, investment grade, tax-exempt bond market. Returns and attributes for this index are calculated semi-monthly using municipal bonds classified as General Obligation Bonds (state and local), Revenue Bonds (excluding insured revenue bonds), Insured Bonds (includes all bond insurers with Aaa/AAA ratings), and Prerefunded Bonds. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union South Carolina Municipal Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP MUNICIPAL BOND RATING DEFINITIONS AAA-- Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA-- Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A-- Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB-- Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. MUNICIPAL BOND RATING DEFINITIONS AAA-- Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA-- Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A-- Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment some time in the future. BAA-- Bonds which are rated BAA are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. G00850-18 (2/95) FIRST UNION VIRGINIA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union Virginia Municipal Bond Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 1 Options and Futures Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 4 Restricted Securities 4 Portfolio Turnover 5 Investment Limitations 5 Virginia Investment Risks 6 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 9 Trustee Compensation 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 11 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 12 Shareholder Services Plan 12 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 13 Use of Amortized Cost 13 Valuing Options 13 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 14 - --------------------------------------------------------------- YIELD 14 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 15 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- FINANCIAL STATEMENTS 16 - --------------------------------------------------------------- APPENDIX 17 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Virginia Municipal Bond Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares, and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income which is exempt from federal regular income tax and Virginia state income tax consistent with preservation of capital. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in a non-diversified portfolio of Virginia municipal securities. PARTICIPATION INTERESTS Participation interests may take the form of participations, beneficial interests in a trust, partnership interests, or any other form of indirect ownership that allows the Fund to treat the income from the investment as exempt from federal and state tax. The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. The terms of these variable rate demand instruments require payment of principal obligations by the issuer of the participation interests or a guarantor of either issuer. All variable rate municipal securities will meet the quality standards for the Fund. The Fund's adviser has been instructed by the Trust's Board of Trustees (the "Trustees") to monitor the pricing, quality, and liquidity of the variable rate municipal securities, including participation interests held by the Fund, on the basis of published financial information and reports of the rating agencies and other analytical services. MUNICIPAL LEASES When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the Fund's adviser to consider certain factors, such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security, the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an "event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. OPTIONS AND FUTURES TRANSACTIONS The Fund may attempt to hedge all or a portion of its portfolio by buying and selling financial futures contracts and options on financial futures contracts. Additionally, the Fund may buy and sell call and put options on portfolio securities. The Fund does not intend to invest more than 5% of its assets in options and futures. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed put and call options on financial futures contracts for U.S. government securities. Unlike entering directly into a futures contract, which requires the purchaser to buy a financial instrument on a set date at a specified price, the purchase of a put option on a futures contract entitles (but does not obligate) its purchaser to decide on or before a future date whether to assume a short position at the specified price. The Fund may purchase put options on futures to protect portfolio securities against decreases in value resulting from an anticipated increase in market interest rates. Generally, if the hedged portfolio securities decrease in value during the term of an option, the related futures contracts will also decrease in value and the option will increase in value. In such an event, the Fund will normally close out its option by selling an identical option. If the hedge is successful, the proceeds received by the Fund upon the sale of the second option will be large enough to offset both the premium paid by the Fund for the original option plus the realized decrease in value of the hedged securities. Alternatively, the Fund may exercise its put option. To do so, it would simultaneously enter into a futures contract of the type underlying the option (for a price less than the strike price of the option) and exercise the option. The Fund would then deliver the futures contract in return for payment of the strike price. If the Fund neither closes out nor exercises an option, the option will expire on the date provided in the option contract, and the premium paid for the contract will be lost. WRITING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS In addition to purchasing put options on futures, the Fund may write listed call options on futures contracts for U.S. government securities to hedge its portfolio against an increase in market interest rates. When the Fund writes a call option on a futures contract, it is undertaking the obligation of assuming a short futures position (selling a futures contract) at the fixed strike price at any time during the life of the option if the option is exercised. As market interest rates rise, causing the prices of futures to go down, the Fund's obligation under a call option on a future (to sell a futures contract) costs less to fulfill, causing the value of the Fund's call option position to increase. In other words, as the underlying futures price goes down below the strike price, the buyer of the option has no reason to exercise the call, so that the Fund keeps the premium received for the option. This premium can offset the drop in value of the Fund's fixed income portfolio which is occurring as interest rates rise. Prior to the expiration of a call written by the Fund, or exercise of it by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of the second option will be less than the premium received by the Fund for the initial option. The net premium income of the Fund will then offset the decrease in value of the hedged securities. WRITING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may write listed put options on financial futures contracts for U.S. government securities to hedge its portfolio against a decrease in market interest rates. When the Fund writes a put option on a futures contract, it receives a premium for undertaking the obligation to assume a long futures position (buying a futures contract) at a fixed price at any time during the life of the option. As market interest rates decrease, the market price of the underlying futures contract normally increases. As the market value of the underlying futures contract increases, the buyer of the put option has less reason to exercise the put because the buyer can sell the same futures contract at a higher price in the market. The premium received by the Fund can then be used to offset the higher prices of portfolio securities to be purchased in the future due to the decrease in market interest rates. Prior to the expiration of the put option, or its exercise by the buyer, the Fund may close out the option by buying an identical option. If the hedge is successful, the cost of buying the second option will be less than the premium received by the Fund for the initial option. PURCHASING CALL OPTIONS ON FINANCIAL FUTURES CONTRACTS An additional way in which the Fund may hedge against decreases in market interest rates is to buy a listed call option on a financial futures contract for U.S. government securities. When the Fund purchases a call option on a futures contract, it is purchasing the right (not the obligation) to assume a long futures position (buy a futures contract) at a fixed price at any time during the life of the option. As market interest rates fall, the value of the underlying futures contract will normally increase, resulting in an increase in value of the Fund's option position. When the market price of the underlying futures contract increases above the strike price plus premium paid, the Fund could exercise its option and buy the futures contract below market price. Prior to the exercise or expiration of the call option the Fund could sell an identical call option and close out its position. If the premium received upon selling the offsetting call is greater than the premium originally paid, the Fund has completed a successful hedge. LIMITATION ON OPEN FUTURES POSITIONS The Fund will not maintain open positions in futures contracts it has sold or call options it has written on futures contracts if, in the aggregate, the value of the open positions (marked to market) exceeds the current market value of its securities portfolio plus or minus the unrealized gain or loss on those open positions, adjusted for the correlation of volatility between the hedged securities and the futures contracts. If this limitation is exceeded at any time, the Fund will take prompt action to close out a sufficient number of open contracts to bring its open futures and options positions within this limitation. "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Fund does not pay or receive money upon the purchase or sale of a futures contract. Rather, the Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with its custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. The Fund may not purchase or sell futures contracts or related options if immediately thereafter the sum of the amount of margin deposits on the Fund's existing futures positions and premiums paid for related options would exceed 5% of the market value of the Fund's total assets. A futures contract held by the Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Fund pays or receives cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by the Fund but is instead settlement between the Fund and the broker of the amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Fund will mark-to-market its open futures positions. The Fund is also required to deposit and maintain margin when it writes call options on futures contracts. PURCHASING AND WRITING PUT AND CALL OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put and call options on portfolio securities to protect against price movements in particular securities. A put option gives the Fund, in return for a premium, the right to sell the underlying security to the writer (seller) at a specified price during the term of the option. A call option gives the Fund, in return for a premium, the right to buy the underlying security from the seller. The Fund may generally purchase and write over-the-counter options on portfolio securities in negotiated transactions with the writers or buyers of the options since options on the portfolio securities held by the Fund are not traded on an exchange. The Fund purchases and writes options only with investment dealers and other financial institutions (such as commercial banks or savings and loan associations) deemed creditworthy by the Fund's adviser. Over-the-counter options are two party contracts with price and terms negotiated between buyer and seller. In contrast, exchange-traded options are third party contracts with standardized strike prices and expiration dates and are purchased from a clearing corporation. Exchange-traded options have a continuous liquid market while over-the-counter options may not. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Fund may enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. RESTRICTED SECURITIES The Fund may invest in restricted securities. Restricted securities are any securities in which the Fund may otherwise invest pursuant to its investment objective and policies but which are subject to restrictions on resale under federal securities laws. The Fund will not invest more than 15% of the value of its net assets in restricted securities; however, certain restricted securities which the Trustees deem to be liquid will be excluded from this 15% limitation. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. PORTFOLIO TURNOVER The Fund may trade or dispose of portfolio securities as considered necessary to meet its investment objective. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of portfolio turnover exceeding 100%. For the fiscal year ended December 31, 1994 and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rates for the Fund were 59% and 0%, respectively. INVESTMENT LIMITATIONS SELLING SHORT AND BUYING ON MARGIN The Fund will not sell any securities short or purchase any securities on margin but may obtain such short-term credits as may be necessary for clearance of purchases and sales of securities. A deposit or payment by the Fund of initial or variation margin in connection with financial futures contracts or related options transactions is not considered the purchase of a security on margin. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amounts borrowed, in order to meet redemption requests without immediately selling portfolio instruments; and except to the extent that the Fund will enter into futures contracts. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, including limited partnership interests, although it may invest in municipal bonds secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities. However, the Fund may purchase put and call options on portfolio securities and on financial futures contracts. In addition, the Fund reserves the right to hedge the portfolio by entering into financial futures contracts and to sell puts and calls on financial futures contracts. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. The Fund may, however, acquire publicly or non-publicly issued municipal bonds or temporary investments or enter into repurchase agreements in accordance with its investment objective, policies, and limitations or the Declaration of Trust. CONCENTRATION OF INVESTMENTS The Fund will not purchase securities if, as a result of such purchase, 25% or more of the value of its total assets would be invested in any one industry, or in industrial development bonds or other securities, the interest upon which is paid from revenues of similar types of projects. However, the Fund may invest as temporary investments more than 25% of the value of its assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate its assets except to secure permitted borrowings. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation of collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities and municipal leases not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in industrial development bonds where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. INVESTING IN MINERALS The Fund will not purchase interests in or sell, oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund has no present intention to borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. The Fund did not invest more than 5% of its net assets in securities of other investment companies in the last fiscal year, and has no present intent to do so during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." VIRGINIA INVESTMENT RISKS The Fund invests in obligations of Virginia issuers, which results in the Fund's performance being subject to risks associated with the overall conditions present within the State. The following information is a brief summary of the recent prevailing economic conditions and a general summary of the State's financial status. This information is based on official statements relating to securities that have been offered by Virginia issuers and from other sources believed to be reliable, but should not be relied upon as a complete description of all relevant information. Virginia's credit strength is derived from a diversified economy, relatively low unemployment rates, strong financial management, and low debt burden. The State's economy benefits significantly from its proximity to Washington D.C. Government is the State's third-largest employment sector, comprising 21% of total employment. Other important sectors of the economy include shipbuilding, tourism, construction, and agriculture. Virginia is a very conservative debt issuer and has maintained debt levels that are low in relation to its substantial resources. Conservative policies also dominate the State's financial operations, and the State administration continually demonstrates its ability and willingness to adjust financial planning and budgeting to preserve financial balance. For example, economic weakness in the State and the region caused personal income and sales and corporate tax collections to fall below projected forecasts and placed the State under budgetary strain. The State reacted by reducing its revenue expectations for the 1990-92 biennium and preserved financial balance through a series of transfers, appropriation reductions, and other budgetary revisions. Management's actions resulted in a modest budget surplus for fiscal 1992, and another modest surplus was reported for fiscal 1993, which ended June 30th. The 1994 Virginia budget experienced a significant surplus due to an improving economy, including job growth of 3.0%/year overall. Overall, Virginia has a stable credit outlook due mainly to its diverse economy and resource base, as well as a conservative approach to financial operations. Revenue growth for 1994 was 6%. Budgets for 1995 and 1996 call for revenue growth of 6.1% and 5.8%, respectively. The Fund's concentration in securities issued by the State and its political subdivisions provides a greater level of risk than a fund which is diversified across numerous states and municipal entities. The ability of the State or its municipalities to meet their obligations will depend on the availability of tax and other revenues; economic, political, and demographic conditions within the State; and the underlying fiscal condition of the State, its counties, and its municipalities. Virginia faces some economic uncertainties with respect to defense-related cutbacks. Although Virginia's unemployment rate of 4.9% (as of August, 1994) is well below the national rate of 5.9%, the State has been able to make some gains in the services, government, and construction sectors when manufacturing and trade were down slightly. The effects of the most recent base-closing legislation were muted because of consolidation from out-of-state bases to Virginia installations. While military operations at the Pentagon are unlikely to be threatened, another round of base-closings scheduled for 1995 may jeopardize a number of Virginia installations. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Carlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank--Capital Management Group ("First Union--CMG"), for the exclusive benefit of Keith Edwards, Charlotte, North Carolina, owned approximately 5,547.202 Shares (12.207%); First Union--CMG, for the exclusive benefit of Henry and Roberta Thompson, Charlotte, North Carolina, owned approximately 5,746.444 Shares (12.646%); and First Union National Bank, Charlotte, North Carolina, owned approximately 33,347.986 Shares (73.387%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union Brokerage Services ("FUBS"), for the exclusive benefit of Judith Z. Watson of Spring Fall, Virginia, owned approximately 11,984.601 Shares (6.482%); FUBS, for the exclusive benefit of Howard S. Barger and Dorothy M. Barger of Bristol, Virginia, owned approximately 10,778.729 Shares (5.830%); FUBS, for the exclusive benefit of Earl Wilson Watts, Jr. M.D. and Barbara Watts of Roanoke, Virginia, owned approximately 10,333.969 Shares (5.589%); and Duff M. Green of Fredericksburg, Virginia, owned approximately 20,803.780 Shares (11.252%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: FUBS, for the exclusive benefit of Harry S. Williams and Patsy Williams of Marion, Virginia, owned approximately 26,721.385 Shares (6.225%); FUBS, for the exclusive benefit of John L. Zepp and Mary Lou Zepp of Vienna, Virginia, owned approximately 22,744.878 Shares (5.299%); and FUBS, for the exclusive benefit of Alma H. Arnold of Leesburg, Virginia, owned approximately 23,345.293 Shares (5.439%). TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Petit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of, $24,942 and $4,283, respectively, all of which were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund paid no commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal year ended December 31, 1994, and for the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $75,479 and $24,931 in administrative service costs, all of which were voluntarily waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $4,028 in distribution services fees on behalf of Class A Investment Shares. For the fiscal year ended December 31, 1994, the Fund incurred $24,447 in distribution services fees on behalf of Class B Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDERS SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $2,897 for Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. USE OF AMORTIZED COST The Trustees have decided that the fair value of debt securities authorized to be purchased by the Fund with remaining maturities of 60 days or less at the time of purchase shall be their amortized cost value, unless the particular circumstances of the security indicate otherwise. Under this method, portfolio instruments and assets are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Trustees periodically assess this method of valuation and recommend changes where necessary to assure that the Fund's portfolio instruments are valued at their fair value as determined in good faith by the Trustees. VALUING OPTIONS Over-the-counter put options will be valued at the mean between the bid and the asked prices. Covered call options will be valued at the last sale price on the national exchange on which such option is traded. Unlisted call options will be valued at the latest bid price as provided by brokers. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS No portion of any income dividend paid by the Fund is eligible for the dividends received deductions available to corporations. CAPITAL GAINS Capital gains or losses may be realized by the Fund on the sale of portfolio securities and as a result of discounts from par value on securities held to maturity. Sales would generally be made because of: the availability of higher relative yields; differentials in market values; new investment opportunities; changes in creditworthiness of an issuer; or an attempt to preserve gains or limit losses. Distribution of long-term capital gains are taxed as such, whether they are taken in cash or reinvested, and regardless of the length of time the shareholder has owned the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total return for Class A Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 7, 1993 (start of performance) to December 31, 1994, was (12.96%) and (6.57%), respectively. The Fund's average annual total return for Class B Investment Shares for the fiscal year ended December 31, 1994, and for the period from July 1, 1993 (start of performance) to December 31, 1994, was (13.63%) and (6.46%), respectively. Average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is compounded by multiplying the number of Shares owned at the end of the period by the net asset value per Share at the end of the period. The number of Shares owned at the end of the period is based on the number of Shares purchased at the beginning of the period with $1,000, less any applicable sales load, adjusted over the period by any additional Shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net asset value of shares redeemed. The Fund's cumulative total return for Y Shares for the period from February 28, 1994 (start of performance) to December 31, 1994, was (5.82%). Cumulative total return reflects the Fund's total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. This total return is representative of only 9 months of activity since the Fund's start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Y Shares, Class A Investment Shares, and Class B Investment Shares were 6.00%, 5.50%, and 5.03%, respectively, for the thirty-day period ended December 31, 1994. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per Share (as defined by the SEC) earned by any class of shares over a thirty-day period by the maximum offering price per share of any class on the last day of the period. This value is then annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by any class because of certain adjustments required by the SEC and, therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yields for Y Shares, Class A Investment Shares, and Class B Investment Shares for the thirty-day period ended December 31, 1994, were 9.06%, 8.30%, and 7.59%, respectively, assuming a 28% federal tax rate and a 5.75% regular personal income tax rate imposed by Virginia, and assuming that income earned by the Fund is 100% tax-exempt on a regular federal, state and local basis. - -------------------------------------------------------------------------------- The tax equivalent yield for all classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that any class would have had to earn to equal its actual yield, assuming that income is 100% tax- exempt. TAX EQUIVALENCY TABLE Each class of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the portfolio generally remains free from federal regular income tax,* and is often free from state and local taxes as well. As the table below indicates, a "tax free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields.
TAXABLE YIELD EQUIVALENT FOR 1995 STATE OF VIRGINIA - ------------------------------------------------------------------------------- COMBINED FEDERAL AND STATE INCOME TAX BRACKET: 20.75% 33.75% 36.75% 41.75% 45.35% - ------------------------------------------------------------------------------- JOINT $1- $39,001- $94,251- $143,601- Over RETURN: 39,000 94,250 143,600 256,500 $ 256,500 SINGLE $1- $23,351- $56,551- $117,951- Over RETURN: 23,350 56,550 117,950 256,500 $ 256,600 - ------------------------------------------------------------------------------- TAX-EXEMPT YIELD TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------- 3.50% 4.42% 5.28% 5.53% 6.01% 6.40% 4.00 5.05 6.04 6.32 6.87 7.32 4.50 5.68 6.79 7.11 7.73 8.23 5.00 6.31 7.55 7.91 8.58 9.15 5.50 6.94 8.30 8.70 9.44 10.06 6.00 7.57 9.06 9.49 10.30 10.98 6.50 8.20 9.81 10.28 11.16 11.89 7.00 8.83 10.57 11.07 12.02 12.81 7.50 9.46 11.32 11.86 12.88 13.72 8.00 10.09 12.08 12.65 13.73 14.64
Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. Furthermore, additional state and local taxes paid on comparable taxable investments were not used to increase federal deductions. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of any class of shares. *Some portion of each class's income may be subject to the federal alternative minimum tax and state and local taxes. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specific period of time. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC. an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS VIRGINIA MUNICIPAL BOND INDEX is a total return performance benchmark for the Virginia long-term, investment grade, tax-exempt bond market. Returns and attributes for this index are calculated semi-monthly using municipal bonds classified as General Obligation Bonds (state and local), Revenue Bonds (excluding insured revenue bonds), Insured Bonds (includes all bond insurers with Aaa/AAA ratings), and Prerefunded Bonds. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Virginia Municipal Bond Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP MUNICIPAL BOND RATING DEFINITIONS AAA-- Debt rated AAA has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA-- Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A-- Debt rated A has a strong capacity to pay interest and repay principal, although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB-- Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. MUNICIPAL BOND RATING DEFINITIONS AAA-- Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA-- Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in AAA securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A-- Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment some time in the future. BAA-- Bonds which are rated BAA are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. G00850-13 (2/95) FIRST UNION HIGH GRADE TAX FREE PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares or Class B Investment Shares for First Union High Grade Tax Free Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288- 1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Acceptable Investments 1 When-Issued and Delayed Delivery Transactions 1 Temporary Investments 1 Lending of Portfolio Securities 2 Portfolio Turnover 2 Municipal Bond Insurance 2 Municipal Bond Insurers 3 Investment Limitations 4 FIRST UNION FUNDS MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 8 Trustee Compensation 8 Trustee Liability 8 INVESTMENT ADVISORY SERVICES 9 - --------------------------------------------------------------- Adviser to the Fund 9 Advisory Fees 9 BROKERAGE TRANSACTIONS 9 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - --------------------------------------------------------------- PURCHASING SHARES 10 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 11 Shareholder Services Plan 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Determining Market Value of Securities 12 Valuing Municipal Bonds 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 13 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 14 - --------------------------------------------------------------- FINANCIAL STATEMENTS 15 - --------------------------------------------------------------- APPENDIX 16 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union High Grade Tax Free Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The name of the Fund was changed from "First Union Insured Tax Free Portfolio" to "First Union High Grade Tax Free Portfolio" effective February 28, 1994. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Prior to that, the Fund had changed its name from "The Salem Tax Free Portfolio" to "The Salem Insured Tax Free Portfolio" on January 9, 1992. Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares, and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide a high level of federally tax free income that is consistent with preservation of capital. The objective cannot be changed without approval of shareholders. ACCEPTABLE INVESTMENTS The Fund invests primarily in high grade municipal bonds. CHARACTERISTICS The municipal bonds in which the Fund invests have the characteristics set forth in the prospectus. If ratings made by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group ("S&P") change because of changes in those organizations or in their rating systems, the Fund will try to use comparable ratings as standards in accordance with the investment policies described in the respective prospectuses. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. TEMPORARY INVESTMENTS The Fund may also invest in temporary investments from time to time for defensive purposes. The Fund might invest in temporary investments: .as a reaction to market conditions; .while waiting to invest proceeds of sales of Shares or portfolio securities, although generally proceeds from sales of Shares will be invested in municipal bonds as quickly as possible; or .in anticipation of redemption requests. The Fund will not purchase temporary investments (other than securities of the U.S. government, its agencies, or instrumentalities) if, as a result of the purchase, more than 25% of the value of its total assets would be invested in any one industry. However, the Fund may, for temporary defensive purposes, invest more than 25% of the value of its assets in cash or cash items (including bank time and demand deposits, such as certificates of deposit), U.S. Treasury bills, or securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments, such as repurchase agreements. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or certificates of deposit to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price within one year from the date of acquisition. The Fund or its custodian will take possession of the securities subject to repurchase agreements. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund may only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are found by the Fund's adviser to be creditworthy pursuant to guidelines established by the Board of Trustees ("Trustees"). From time to time, such as when suitable municipal bonds are not available, the Fund may invest a portion of its assets in cash. Any portion of the Fund's assets maintained in cash will reduce the amount of assets in municipal bonds and thereby reduce the Fund's yield. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. This transaction is similar to borrowing cash. In a reverse repurchase agreement, the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. PORTFOLIO TURNOVER The Fund will not attempt to set or meet a portfolio turnover rate, since any turnover would be incidental to transactions undertaken in an attempt to achieve the Fund's investment objective. The portfolio turnover rates for the fiscal years ended December 31, 1994 and 1993 were 53% and 14%, respectively. MUNICIPAL BOND INSURANCE The Fund may purchase two types of municipal bond insurance policies ("Policies") issued by municipal bond insurers. One type of Policy covers certain municipal securities only during the period in which they are in the Fund's portfolio. In the event that a municipal security covered by such a Policy is sold by the Fund, the insurer of the relevant Policy will be liable only for those payments of interest and principal which are then due and owing at the time of sale. The other type of Policy covers municipal securities not only while they remain in the Fund's portfolio but also until their final maturity, even if they are sold out of the Fund's portfolio, so that the coverage may benefit all subsequent holders of those municipal securities. The Fund will obtain insurance which covers municipal securities until final maturity even after they are sold out of the Fund's portfolio only if, in the judgment of the adviser, the Fund would receive net proceeds from the sale of those securities, after deducting the cost of such permanent insurance and related fees, significantly in excess of the proceeds it would receive if such municipal securities were sold without insurance. Payments received from municipal bond insurers may not be tax-exempt income to shareholders of the Fund. Depending upon the characteristics of the municipal security held by the Fund, the annual premiums for the Policies are estimated to range from 0.10% to 0.25% of the value of the municipal securities covered under the Policies, with an average annual premium rate of approximately 0.175%. The Fund may purchase Policies from Municipal Bond Investors Assurance Corp. ("MBIA"), AMBAC Indemnity Corporation ("AMBAC"), Financial Guaranty Insurance Company ("FGIC"), each as described under "Municipal Bond Insurers," or any other municipal bond insurer which is rated Aaa by Moody's or AAA by S&P. Each Policy guarantees the payment of principal and interest on those municipal securities it insures. The Policies will have the same general characteristics and features. A municipal security will be eligible for coverage if it meets certain requirements set forth in a Policy. In the event interest or principal on an insured municipal security is not paid when due, the insurer covering the security will be obligated under its Policy to make such payment not later than 30 days after it has been notified by the Fund that such non-payment has occurred. MBIA, AMBAC, and FGIC will not have the right to withdraw coverage on securities insured by their Policies so long as such securities remain in the Fund's portfolio, nor may MBIA, AMBAC, or FGIC cancel their Policies for any reason except failure to pay premiums when due. MBIA, AMBAC, and FGIC will reserve the right at any time upon 90 days' written notice to the Fund to refuse to insure any additional municipal securities purchased by the Fund after the effective date of such notice. The Trustees will reserve the right to terminate any of the Policies if it determines that the benefits to the Fund of having its portfolio insured under such Policy are not justified by the expense involved. Additionally, the Trustees reserve the right to enter into contracts with insurance carriers other than MBIA, AMBAC, or FGIC, if such carriers are rated Aaa by Moody's or AAA by S&P. Under the Policies, municipal bond insurers unconditionally guarantee to the Fund the timely payment of principal and interest on the insured municipal securities when and as such payments shall become due but shall not be paid by the issuer, except that in the event of any acceleration of the due date of the principal by reason of mandatory or optional redemption (other than acceleration by reason of mandatory sinking fund payments), default or otherwise, the payments guaranteed will be made in such amounts and at such times as payments of principal would have been due had there not been such acceleration. The municipal bond insurers will be responsible for such payments less any amounts received by the Fund from any trustee for the municipal bond holders or from any other source. The Policies do not guarantee payment on an accelerated basis, the payment of any redemption premium, the value for the Shares of the Fund, or payments of any tender purchase price upon the tender of the municipal securities. The Policies also do not insure against nonpayment of principal of or interest on the securities resulting from the insolvency, negligence or any other act or omission of the trustee or other paying agent for the securities. However, with respect to small issue industrial development municipal bonds and pollution control revenue municipal bonds covered by the Policies, the municipal bond insurers guarantee the full and complete payments required to be made by or on behalf of an issuer of such municipal securities if there occurs any change in the tax-exempt status of interest on such municipal securities, including principal, interest or premium payments, if any, as and when required to be made by or on behalf of the issuer pursuant to the terms of such municipal securities. A when-issued municipal security will be covered under the Policies upon the settlement date of the original issue of such when-issued municipal securities. In determining whether to insure municipal securities held by the Fund, each municipal bond insurer has applied its own standard, which corresponds generally to the standards it has established for determining the insurability of new issues of municipal securities. This insurance is intended to reduce financial risk, but the cost thereof and compliance with investment restrictions imposed under the Policies and these guidelines will reduce the yield to shareholders of the Fund. If a Policy terminates as to municipal securities sold by the Fund on the date of sale, in which event municipal bond insurers will be liable only for those payments of principal and interest that are then due and owing, the provision for insurance will not enhance the marketability of securities held by the Fund, whether or not the securities are in default or subject to significant risk of default, unless the option to obtain permanent insurance is exercised. On the other hand, since issuer-obtained insurance will remain in effect as long as the insured municipal securities are outstanding, such insurance may enhance the marketability of municipal securities covered thereby, but the exact effect, if any, on marketability cannot be estimated. The Fund generally intends to retain any securities that are in default or subject to significant risk of default and to place a value on the insurance, which ordinarily will be the difference between the market value of the defaulted security and the market value of similar securities of minimum high grade (i.e., rated A by Moody's or S&P) that are not in default. To the extent that the Fund holds defaulted securities, it may be limited in its ability to manage its investment and to purchase other municipal securities. Except as described above with respect to securities that are in default or subject to significant risk of default, the Fund will not place any value on the insurance in valuing the municipal securities that it holds. MUNICIPAL BOND INSURERS Municipal bond insurance may be provided by one or more of the following insurers or any other municipal bond insurer which is rated Aaa by Moody's or AAA by S&P. MUNICIPAL BOND INVESTORS ASSURANCE CORP. Municipal Bond Investors Assurance Corp. is a wholly-owned subsidiary of MBIA, Inc., a Connecticut insurance company, which is owned by AEtna Life and Casualty, Credit Local DeFrance CAECL, S.A., The Fund American Companies, and the public. The investors of MBIA, Inc., are not obligated to pay the obligations of MBIA. MBIA, domiciled in New York, is regulated by the New York State Insurance Department and licensed to do business in various states. The address of MBIA is 113 King Street, Armonk, New York, 10504, and its telephone number is (914) 273-4345. S&P has rated the claims-paying ability of MBIA AAA. AMBAC INDEMNITY CORPORATION AMBAC Indemnity Corporation is a Wisconsin-domiciled stock insurance company, regulated by the Insurance Department of Wisconsin, and licensed to do business in various states. AMBAC is a wholly-owned subsidiary of AMBAC, Inc., a financial holding company which is owned by the public. Copies of certain statutorily required filings of AMBAC can be obtained from AMBAC. The address of AMBAC's administrative offices is One State Street Plaza, 17th Floor, New York, New York 10004, and its telephone number is (212) 668-0340. S&P has rated the claims-paying ability of AMBAC AAA. FINANCIAL GUARANTY INSURANCE COMPANY Financial Guaranty Insurance Company is a wholly-owned subsidiary of FGIC Corporation, a Delaware holding company. FGIC Corporation is wholly-owned by General Electric Capital Corporation. The investors of FGIC Corporation are not obligated to pay the debts of or the claims against Financial Guaranty. Financial Guaranty is subject to regulation by the state of New York Insurance Department and is licensed to do business in various states. The address of Financial Guaranty is 115 Broadway, New York, New York 10006, and its telephone number is (212) 312-3000. S&P has rated the claims-paying ability of Financial Guaranty AAA. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. The use of short sales will allow the Fund to retain certain bonds in its portfolio longer than it would without such sales. To the extent the Fund receives the current income produced by such bonds for a longer period than it might otherwise, the Fund's investment objective of current income is furthered. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes in an amount up to one-third of the value of its total assets, including the amount borrowed, in order to meet redemption requests without immediately selling portfolio instruments. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of the value of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. INVESTING IN REAL ESTATE The Fund will not buy or sell real estate, although it may invest in the securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. RESTRICTED SECURITIES The Fund will not invest more than 10% of its total assets in securities subject to restrictions on resale under the federal securities laws. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets except that it may purchase or hold money market instruments, including repurchase agreements and variable amount demand master notes, in accordance with its investment objective, policies and limitations and lend portfolio securities valued at not more than 15% of its total assets to broker/dealers. CONCENTRATION OF INVESTMENTS The Fund will not invest more than 25% of the value of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities and in industrial development bonds, as long as they are not from the same facility or similar types of facilities. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its total assets, the Fund will not purchase securities of any one issuer (other than cash, cash items or securities issued or guaranteed by the U.S. government, its agencies or instrumentalities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. Under this limitation, each governmental subdivision, including states and the District of Columbia, territories, possessions of the United States, or their political subdivisions, agencies, authorities, instrumentalities, or similar entities, will be considered a separate issuer if its assets and revenues are separate from those of the governmental body creating it and the security is backed only by its own assets and revenues. Industrial development bonds, backed only by the assets and revenues of a nongovernmental issuer, are considered to be issued solely by that issuer. If, in the case of an industrial development bond or governmental-issued security, a governmental or other entity guarantees the security, such guarantee would be considered a separate security issued by the guarantor as well as the other issuer, subject to limited exclusions allowed by the Investment Company Act of 1940. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses, such as management fees, and therefore, any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 15% of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, and certain restricted securities not determined by the Trustees to be liquid. The above investment limitations cannot be changed without shareholder approval. The following investment limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser owning individually more than 1/2 of 1% of the issuer's securities together own more than 5% of the issuer's securities. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of its total assets in industrial development bonds or other municipal securities where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. Although not a fundamental restriction or policy requiring a shareholder vote, the Fund has also undertaken to comply with the following limitation to a state securities authority for as long as the state authority requires and Shares of the Fund are registered for sale in that state: INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money, invest in reverse repurchase agreements, or sell securities short in excess of 5% of the value of its net assets in the last fiscal year and has no present intent to do so in the coming fiscal year. In addition, the Fund does not intend to invest more than 25% of the value of its assets in any issuer in a single state. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." The Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, birthdates, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Senior Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholder of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank, Charlotte, NC owned approximately 398,873.093 Shares (91.900%). As of February 7, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund. As of February 7, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. TRUSTEE COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993 and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, the Adviser earned advisory fees of $599,854, $643,946 and $356,258, of which $16,091, $280,300 and $269,964, respectively, were voluntarily waived. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal year ended December 31, 1994 and 1993, the Fund paid no commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, the Fund incurred $101,004, $112,663 and $65,451 in administrative service costs, of which $0, $0 and $25,395 were waived, respectively. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: . quantity discounts and accumulated purchases; . signing a 13-month letter of intent; . using the reinvestment privilege; or . concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. The Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, the Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. The Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in the Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in the Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in the Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of the Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. The Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission ("SEC") pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal years ended December 31, 1994 and 1993, and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, the Fund incurred $197,562, $254,815, and $178,122, respectively, in distribution services fees on behalf of Class A Investment Shares, of which $0, $2,256 and $149,539 were voluntarily waived. For the fiscal year ended December 31, 1994, and for the period from January 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $287,858 and $201,475, respectively, in distribution services fees on behalf of Class B Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred shareholder services fees of $26,443 on behalf of Class B Investment Shares. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES Market values of the Fund's portfolio securities are determined as follows: .according to the last sale price on a national securities exchange, if available; .in the absence of recorded sales for equity securities, according to the mean between the current closing bid and asked prices and for bonds and other fixed income securities as determined by an independent pricing service; .for short-term obligations, according to the mean between bid and asked prices, as furnished by an independent pricing service, or for short-term obligations with remaining maturities of 60 days or less at the time of purchase, at amortized cost, unless the Trustees determines this is not fair value; or .at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices. Pricing services may consider: .yield; .quality; .coupon rate; .maturity; .type of issue; .trading characteristics; and .other market data. VALUING MUNICIPAL BONDS The Trustees use an independent pricing service to value municipal bonds. The independent pricing service takes into consideration yield, stability, risk, quality, coupon rate, maturity, type of issue, trading characteristics, special circumstances of a security or trading market, and any other factors or market data it considers relevant in determining valuations for normal institutional size trading units of debt securities, and does not rely exclusively on quoted prices. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. TOTAL RETURN - -------------------------------------------------------------------------------- The Fund's average annual total returns for Class A Investment Shares for the one-year period ended December 31, 1994, and for the period from February 25, 1992 (start of performance) to December 31, 1994, were (12.12%) and 3.03%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1994, and for the period from January 12, 1993 (start of performance) to December 31, 1994 were (12.81%) and (0.48%), respectively. The average annual total return for all classes of Shares of the Fund is the average compounded rate of return for a given period that would equate a $1,000 initial investment to the ending redeemable value of that investment. The ending redeemable value is computed by multiplying the number of shares owned at the end of the period by the net asset value per share at the end of the period. The number of shares owned at the end of the period is based on the number of shares purchased at the beginning of the period with $1,000 less any applicable sales load, adjusted over the period by any additional shares, assuming the monthly reinvestment of all dividends and distributions. Any applicable contingent deferred sales charge is deducted from the ending value of the investment based on the lesser of the original purchase price or the net aset value of Shares redeemed. The Fund's cumulative total return for Y Shares for the period from February 28, 1994 (start of performance) to December 31, 1994 was (6.31%). Cumulative total return reflects the Y Shares' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load, if applicable and any contingent deferred sales charge. The Y Shares' total return is representative of only 10 months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the thirty-day period ended December 31, 1994 was 5.85%. The Fund's yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 5.33%. The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 4.85%. The yield for all classes of Shares of the Fund is determined by dividing the net investment income per share (as defined by the SEC) earned by each class of Shares over a thirty-day period by the maximum offering price per share of each class on the last day of the period. This value is annualized using semi-annual compounding. This means that the amount of income generated during the thirty-day period is assumed to be generated each month over a twelve-month period and is reinvested every six months. The yield does not necessarily reflect income actually earned by each class because of certain adjustments required by the SEC and therefore, may not correlate to the dividends or other distributions paid to shareholders. To the extent that financial institutions and brokers/dealers charge fees in connection with services provided in conjunction with an investment in all classes of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yield for Y Shares for the thirty-day period ended December 31, 1994 was 8.13%. The Fund's tax equivalent yield for Class A Investment Shares for the thirty-day period ended December 31, 1994 was 7.40%. The Fund's tax equivalent yield for Class B Investment Shares for the thirty-day period ended December 31, 1994 was 6.74%. The tax equivalent yield for all classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that each class would have had to earn to equal its actual yield, assuming a 28% federal tax rate and assuming that income is 100% tax-exempt on a federal, state, and local basis. TAX EQUIVALENCY TABLE Each class of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the Fund's portfolio generally remains free from federal regular income tax,* and are often free from state and local taxes as well. As the table below indicates, a "tax free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields.
TAXABLE YIELD EQUIVALENT FOR 1995 - ------------------------------------------------------------------------------- FEDERAL INCOME TAX BRACKET: 15.00% 28.00% 31.00% 36.00% 39.60% - ------------------------------------------------------------------------------- JOINT $1- $39,001- $94,251- $143,601- Over RETURN: 39,000 94,250 143,600 256,500 $ 256,500 SINGLE $1- $23,351- $56,551- $117,951- Over RETURN: 23,350 56,550 117,950 256,500 $ 256,500 - ------------------------------------------------------------------------------- TAX-EXEMPT YIELD TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------- 1.00% 1.18% 1.39% 1.45% 1.56% 1.66% 1.50 1.76 2.08 2.17 2.34 2.48 2.00 2.35 2.78 2.90 3.13 3.31 2.50 2.94 3.47 3.62 3.91 4.14 3.00 3.53 4.17 4.35 4.69 4.97 3.50 4.12 4.86 5.07 5.47 5.79 4.00 4.71 5.56 5.80 6.25 6.62 4.50 5.29 6.25 6.52 7.03 7.45 5.00 5.88 6.94 7.25 7.81 8.28 5.50 6.47 7.64 7.97 8.59 9.11 6.00 7.06 8.33 8.70 9.38 9.93 6.50 7.65 9.03 9.42 10.16 10.76 7.00 8.24 9.72 10.14 10.94 11.59 7.50 8.82 10.42 10.87 11.72 12.42 8.00 9.41 11.11 11.59 12.50 13.25
Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of any class of Shares. *Some portion of each class' income may be subject to the federal alternative minimum tax and state and local taxes. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in the Fund's or any class of Shares' expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all income dividends and capital gains distributions, if any. From time to time, the Fund will quote its Lipper ranking in the "general municipal bond funds" category in advertising and sales literature. .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. .LEHMAN BROTHERS INSURED BOND INDEX reflects total performance of the Insured Bond sector of the Lehman Brothers Municipal Bond Index. The index includes all bond insurers with Aaa/AAA ratings. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union High Grade Tax Free Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Tax-Free Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectuses. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP BOND RATING DEFINITIONS AAA--Debt rated "AAA" has the highest rating assigned by Standard & Poor's Ratings Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated "AA" has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated "A" has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. MOODY'S INVESTORS SERVICE, INC. BOND RATING DEFINITIONS AAA--Bonds which are rated "AAA" are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edge." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated "AA" are judged to be of high quality by all standards. Together with the "AAA" group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in "AAA" securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in "AAA" securities. A--]Bonds which are rated "A" possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. G00850-20 (2/95) PROSPECTUS FIRST UNION MONEY MARKET FUNDS Y SHARES FEBRUARY 28, 1995 FIRST UNION MONEY MARKET FUNDS Portfolios of First Union Funds ------------------------ ------------------------ - ------------------------ ------------------------ Y SHARES - ------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes three diversified Money Market Funds, three diversified Income Funds, three diversified Growth and Income Funds, two diversified Growth Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Money Market Funds .First Union Money Market Portfolio; .First Union Tax Free Money Market Portfolio; and .First Union Treasury Money Market Portfolio. Income Funds .First Union Fixed Income Portfolio; .First Union Managed Bond Portfolio; and .First Union U.S. Government Portfolio. Growth and Income Funds .First Union Balanced Portfolio; .First Union Utility Portfolio; and .First Union Value Portfolio Growth Funds .First Union Emerging Markets Growth Portfolio; and .First Union International Equity Portfolio. Tax-Free Funds .First Union Florida Municipal Bond Portfolio; .First Union Georgia Municipal Bond Portfolio; .First Union North Carolina Municipal Bond Portfolio. .First Union South Carolina Municipal Bond Portfolio; .First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio; (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Y Shares of First Union Money Market Funds. It concisely describes the information which you should know before investing in Y Shares of any of the First Union Money Market Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Money Market Fund in its Statement of Additional Information, dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222- 3779 or by calling 1-800- 326-2584. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. First Union Money Market Funds attempt to maintain a stable net asset value of $1.00 per share; there can be no assurance that the First Union Money Market Funds will be able to do so. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF - ------------------------- ------------------------- - ------------------------- ------------------------- CONTENTS Summary 2 How to Convert Your Investment from - -------------------------------------- One First Union Fund to Another First Union Fund 19 Summary of Fund Expenses 4 -------------------------------------- - -------------------------------------- How to Redeem Shares 20 Financial Highlights 5 -------------------------------------- - -------------------------------------- Management of First Union Funds 20 Investment Objectives and Policies 9 -------------------------------------- - -------------------------------------- Fees and Expenses 21 First Union Money Market Portfolio 9 -------------------------------------- - -------------------------------------- Shareholder Rights and Privileges 22 First Union Tax Free Money Market -------------------------------------- Portfolio 11 - -------------------------------------- Distributions and Taxes 24 -------------------------------------- First Union Treasury Money Market Portfolio 13 Tax Information 25 - -------------------------------------- -------------------------------------- Other Investment Policies 13 Other Classes of Shares 26 - -------------------------------------- -------------------------------------- Shareholder Guide 17 Shareholder Reports 26 - -------------------------------------- -------------------------------------- How to Buy Shares 18 Addresses 27 - -------------------------------------- -------------------------------------- SUMMARY - ------------------------- ------------------------- - ------------------------- ------------------------- DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. First Union Tax Free Money Market Portfolio and First Union Treasury Money Market Portfolio are divided into two classes of shares: Y Shares and Class A Investment Shares ("Class A Shares"). In addition, First Union Money Market Portfolio offers three classes of shares: Y Shares, Class A Shares, and Class B Investment Shares ("Class B Shares"). Y Shares are designed primarily for institutional investors (banks, corporations and fiduciaries). Class A and Class B Shares are sold to individuals and other customers of First Union (the "Adviser"). This prospectus relates only to Y Shares ("Shares") of First Union Money Market Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following three Money Market Funds: . First Union Money Market Portfolio ("Money Market Fund")--seeks to provide current income from short-term securities while preserving capital and maintaining liquidity; . First Union Tax Free Money Market Portfolio ("Tax Free Money Market Fund")-- seeks to provide current income exempt from federal regular income tax, while preserving capital and maintaining liquidity; and . First Union Treasury Money Market Portfolio ("Treasury Money Market Fund")-- seeks to achieve stability of principal and current income consistent with stability of principal. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Y Shares of any of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares."
SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION MONEY MARKET FUNDS Y SHARES Tax Free Treasury Money Money Money Market Market Market Fund Fund Fund ------ -------- -------- Y Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price).................. None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................. None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable)............... None None None Redemption Fee (as a percentage of amount redeemed, if applicable).......................................... None None None Exchange Fee.......................................... None None None Annual Y Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1)..................... 0.13% 0.26% 0.17% 12b-1 Fees............................................ None None None Total Other Expenses.................................. 0.35% 0.13% 0.13% Total Y Shares Operating Expenses (2)............. 0.48% 0.39% 0.30%
(1) The management fees have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee is 0.35%. (2) The Total Operating Expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds were 0.41%, 0.31% and 0.20%, respectively, for the fiscal year ended December 31, 1994. Total Y Shares Operating Expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds, absent the voluntary waivers of the management fee by the Adviser were 0.68%, 0.49% and 0.48%, respectively, for the fiscal year ended December 31, 1994. The Annual Y Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The total Y Shares expected operating expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds would be 0.70%, 0.48% and 0.48%, respectively, absent the voluntary waivers described above in note 1. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Y Shares. Money Market Fund........................... $5 $15 $27 $60 Tax Free Money Market Fund.................. $4 $13 $22 $49 Treasury Money Market Fund.................. $3 $10 $17 $38 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Y Shares of the Funds. The Money Market Fund also offers two additional classes of shares, called Class A Shares and Class B Shares. The Tax Free Money Market Fund and the Treasury Money Market Fund also offer an additional class of shares called Class A Shares. Class A Shares are subject to a 12b-1 fee of 0.35 of 1% and bear no sales load. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. See "Other Classes of Shares." FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Y Shares ------------------------------- Year Ended December 31, ------------------------------- 1994 1993 1992 1991* - ---------------------------------------- ------- ------ ------ ------ Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------------------------- Income from investment operations - ---------------------------------------- Net investment income 0.04 0.03 0.03 0.06 - ---------------------------------------- ------ ------ ------ ------ Less distributions - ---------------------------------------- Dividends to shareholders from net in- (0.04) (0.03) (0.03) (0.06) vestment income ------ ------ ------ ------ - ---------------------------------------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------------------------- ------ ------ ------ ------ Total return+ 4.02% 2.99% 3.43% 5.91% - ---------------------------------------- Ratios to Average Net Assets - ---------------------------------------- Expenses 0.41% 0.47% 0.64% 0.58%(b) - ---------------------------------------- Net investment income 3.99% 2.96% 3.34% 5.24%(b) - ---------------------------------------- Expense waiver/ reimbursement (a) 0.27% 0.24% 0.11% 0.26%(b) - ---------------------------------------- Supplemental Data - ---------------------------------------- Net assets, end of period (000 omitted) $10,403 $9,115 $9,243 $5,550 - ---------------------------------------- * Reflects operations for the period from January 3, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis.
FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Class B Investment Class A Investment Shares Shares --------------------------------------------------------------- ------------ Year Ended Year Ended Year Ended December 31, March 31, December 31, ------------------------------------------- --------------- ------------ 1994 1993 1992 1991 1990* 1990 1989** 1994*** - ------------------------ ------- ------- ------- ------- ------- ------- ------ ------------ Net asset value, begin- ning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.04 0.03 0.03 0.05 0.06 0.09 0.02 0.03 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment (0.04) (0.03) (0.03) (0.05) (0.06) (0.09) (0.02) (0.03) income ------ ------ ------ ------ ------ ------ ------ ------ - ------------------------ Net asset value, end of $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 period ------ ------ ------ ------ ------ ------ ------ ------ - ------------------------ Total return+ 3.81% 2.83% 3.24% 5.68% 6.07% 8.96% 2.12% 2.79% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.61% 0.62% 0.82% 0.73% 0.42%(b) 0.35% 0.35%(b) 1.30%(b) - ------------------------ Net investment income 3.79% 2.81% 3.18% 5.45% 7.85%(b) 8.50% 8.85%(b) 3.63%(b) - ------------------------ Expense waiver/reimbursement (a) 0.37% 0.39% 0.24% 0.33% 0.66%(b) 0.51% 0.23%(b) 0.26%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of period (000 omitted) $95,760 $88,171 $64,794 $64,457 $32,216 $21,898 $6,850 $11,722 - ------------------------
* Nine months ended December 31, 1990. ** Reflects operations for the period from January 3, 1989 (commmencement of operations) to March 31, 1989. *** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Tax Free Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Y Shares --------------------------------- Year Ended December 31, --------------------------------- 1994 1993 1992 1991* - ---------------------- ------- ------ ------- ------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------- Income from investment operations - ---------------------- Net investment 0.03 0.02 0.03 0.01 income ------ ------ ------ ------ - ---------------------- Less distributions - ---------------------- Dividends to shareholders from net (0.03) (0.02) (0.03) (0.01) investment income ------ ------ ------ ------ - ---------------------- Net asset value, $ 1.00 $ 1.00 $ 1.00 $ 1.00 end of period ------ ------ ------ ------ - ---------------------- Total return+ 2.91% 2.38% 2.78% 4.49% - ---------------------- Ratios to Average Net Assets - ---------------------- Expenses 0.31% 0.29% 0.51% 0.63%(b) - ---------------------- Net investment income 2.90% 2.37% 2.76% 4.30%(b) - ---------------------- Expense waiver/ reimbursement (a) 0.18% 0.24% 0.09% 0.22%(b) - ---------------------- Supplemental Data - ---------------------- Net assets, end of period (000 omitted) $20,636 $3,377 $17,084 $37,546 - ----------------------
Class A Investment Shares ----------------------------------------------------------------------- Year Ended Year Ended December 31, March 31, -------------------------------------------------- -------------------- 1994 1993 1992 1991 1990** 1990 1989*** - ----------------------- --------- --------- --------- -------- ----------- -------- ----------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ----------------------- Income from investment operations - ----------------------- Net investment 0.03 0.02 0.03 0.04 0.04 0.06 0.01 income ------ ------ ------ ------ ------ ------ ------ - ----------------------- Less distributions - ----------------------- Dividends to shareholders from net (0.03) (0.02) (0.03) (0.04) (0.04) (0.06) (0.01) investment income ----- ------ ------ ------ ------ ------ ------ - ----------------------- Net asset value, $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 end of period ------ ------ ------ ------ ------ ------ ------ - ----------------------- Total return+ 2.61% 2.16% 2.57% 4.20% 4.17% 3.81% 1.28% - ----------------------- Ratios to Average Net Assets - ----------------------- Expenses 0.61% 0.52% 0.69% 0.77% 0.65%(b) 0.65% 0.89%(b) - ----------------------- Net investment income 2.60% 2.16% 2.51% 4.09% 5.45%(b) 5.71% 5.53%(b) - ----------------------- Expense waiver/ reimbursement (a) 0.18% 0.30% 0.20% 0.22% 0.19%(b) 0.06% 0.00%(b) - ----------------------- Supplemental Data - ----------------------- Net assets, end of period (000 omitted) $395,612 $278,451 $184,211 $86,481 $48,603 $36,688 $37,207 - -----------------------
*Reflects operations for the period from January 3, 1991 (commencement of operations) to December 31, 1991. **Nine months ended December 31, 1990. ***Reflects operations for the period from January 3, 1989 (commencement of operations) to March 31, 1989. +Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a)This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (b)Computed on an annualized basis. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Treasury Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Y Shares Class A Investment Shares -------------------------------------- ------------------------------------ Year Ended December 31, Year Ended December 31, -------------------------------------- ------------------------------------ 1994 1993 1992 1991* 1994 1993 1992 1991* - ------------------------ -------- -------- -------- -------- -------- -------- -------- ------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.04 0.03 0.04 0.05 0.04 0.03 0.03 0.04 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment (0.04) (0.03) (0.04) (0.05) (0.04) (0.03) (0.03) (0.04) income ----- ------ ------ ------ ----- ------ ------ ------ - ------------------------ Net asset value, end of $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 period ------ ------ ------ ------ ------ ------ ------ ------ - ------------------------ Total return+ 4.06% 3.04% 3.67% 4.66% 3.75% 2.73% 3.36% 4.46% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.20% 0.18% 0.17% 0.20%(b) 0.50% 0.48% 0.48% 0.47%(b) - ------------------------ Net investment income 3.78% 3.00% 3.61% 5.53%(b) 3.91% 2.70% 3.22% 4.95%(b) - ------------------------ Expense waiver/ reimbursement (a) 0.28% 0.34% 0.35% 0.32%(b) 0.28% 0.34% 0.34% 0.61%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of period (000 omitted) $162,921 $366,109 $286,230 $265,109 $755,050 $261,475 $208,792 $99,549 - ------------------------
* Reflects operations for the period from March 6, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. INVESTMENT OBJECTIVES AND - ------------------------- ------------------------- - ------------------------- ------------------------- POLICIES First Union Money Market Funds provide a range of objectives and policies intended to provide current income while preserving capital and maintaining liquidity. The investment objectives and policies of each Fund are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Current income from short-term securities while preserving capital and maintaining liquidity. Invests in: High quality money market instruments. Suitable for: Conservative investors looking for a cash-equivalent investment. Key Benefit: Safety of principal with a generally better yield than passbook savings accounts. DESCRIPTION OF THE FUND First Union Money Market Fund seeks to provide current income from short-term securities while preserving capital and maintaining liquidity. The Fund invests exclusively in a portfolio of high quality money market instruments maturing in 397 days or less, with an average dollar-weighted maturity of 90 days or less. TYPES OF INVESTMENTS The Fund invests in high quality money market instruments that are rated in the highest short-term rating category by major rating organizations (referred to as "NRSROs" or "nationally recognized statistical rating organizations"), such as Standard & Poor's Ratings Group ("S&P") or Moody's Investors Service, Inc. ("Moody's"), or are of comparable quality to securities having such ratings. Examples of these instruments include, but are not limited to: commercial paper; variable amount demand master notes (a borrowing arrangement between a commercial paper issuer (borrower) and an institutional lender such as the Fund which is payable upon demand. The underlying amount of the loan may vary during the course of the contract, as may the interest on the outstanding amount, depending on a stated short-term interest rate index.); instruments of domestic banks and foreign banks (such as certificates of deposit, demand and time deposits, saving shares, and bankers' acceptances) if they have capital, surplus, and undivided profits of over $100,000,000 and/or if their deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). These instruments may include Eurodollar Certificates of Deposit ("ECDs"), Yankee Certificates of Deposit ("Yankee CDs"), and Eurodollar Time Deposits ("ETDs"), all of which are U.S. dollar denominated; marketable obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities, including these obligations purchased on a when-issued or delayed delivery basis; corporate obligations; and repurchase agreements and reverse repurchase agreements for securities listed above and instruments secured by obligations described above. CONCENTRATION OF INVESTMENTS The Fund may invest more than 25% of its total assets in commercial paper issued by commercial or consumer finance companies. The Fund may also invest more than 25% of the value of its total assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, or instruments secured by these money market instruments, i.e., repurchase agreements. RISK FACTORS ECDs, ETDs, and Yankee CDs are subject to different risks than domestic obligations of domestic banks or corporations. Examples of these risks include international, economic and political developments, foreign governmental restrictions that may adversely affect the payment of principal or interest, foreign withholdings or other taxes on interest income, difficulties in obtaining or enforcing a judgment against the issuing entity, and the possible impact of interruptions in the flow of international currency transactions. Different risks may also exist for ECDs, ETDs, and Yankee CDs because the banks issuing these instruments, or their domestic or foreign branches, are not necessarily subject to the same regulatory requirements that apply to domestic banks, such as reserve requirements, loan limitations, examinations, accounting, auditing, and recordkeeping, and the public availability of information. These factors will be carefully considered by the Adviser in selecting investments for the Fund. FIRST UNION TAX FREE MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Current income exempt from federal regular income tax, while preserving capital and maintaining liquidity. Invests in: A diversified portfolio of short-term municipal securities. Suitable for: Investors seeking tax free monthly income. Key Benefit: Greater diversification and liquidity than can be achieved by purchasing individual municipal securities. DESCRIPTION OF THE FUND First Union Tax Free Money Market Fund seeks to provide current income exempt from federal regular income tax, while preserving capital and maintaining liquidity. The Fund pursues this objective by investing at least 80% of its assets in a diversified portfolio of municipal securities maturing in 397 days or less, with an average dollar-weighted maturity of 90 days or less. As a matter of investment policy which cannot be changed without the approval of shareholders, the Fund will invest its assets so that at least 80% of its annual interest income is exempt from federal income taxes (including the alternative minimum tax). Interest income of the Fund which is exempt from federal regular income tax retains its tax free status when distributed to the Fund's shareholders. TYPES OF INVESTMENTS Municipal bonds are the primary investment of the Fund. Municipal bonds are debt obligations issued by or on behalf of states, territories, and possessions of the United States, including the District of Columbia, and their political subdivisions, agencies, and instrumentalities, the interest from which is exempt from federal regular income tax. In addition, the Fund may buy participation interests in municipal securities. (Participation interests may be purchased from financial institutions such as commercial banks, savings and loan associations and insurance companies and give the Fund an undivided interest in particular municipal securities. The securities which are subject to these participation interests are not limited to maturities of one year or less as long as they include the right to demand payment, typically within seven days, from the issuer.) The municipal securities in which the Fund invests are: bonds rated in the two highest categories by an NRSRO or, if unrated, deemed by the Adviser to be of comparable quality; securities guaranteed at the time of purchase by the U.S. government as to the payment of principal and interest; municipal leases; or notes, tax-exempt commercial paper and variable rate demand obligations rated in the highest category by an NRSRO or if unrated, determined by the Adviser to be of comparable quality. (Variable rate securities offer interest rates which are tied to a money market rate, usually a published interest rate or interest rate index or the 91-day U.S. Treasury bill rate. Many of these securities are subject to prepayment of principal on demand by the Fund, usually in seven days or less. Variable rate municipal securities without the demand feature may not be considered liquid by the Adviser, who will limit investments in illiquid securities to no more than 10% of net assets.) TEMPORARY INVESTMENTS Although the Fund is permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal income tax. During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, the Fund may temporarily invest in short-term money market instruments whose interest income may be taxable to shareholders as ordinary income. These temporary investments include: obligations issued by or on behalf of municipal or corporate issuers having the same quality characteristics as municipal securities purchased by the Fund; marketable obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities; instruments issued by banks or savings and loans which have capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment whose deposits are insured by the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF") (administered by the FDIC), foreign branches of U.S. banks and U.S. branches of foreign banks; repurchase agreements collateralized by eligible investments; prime commercial paper rated A-1 by S&P or P-1 by Moody's; and variable amount demand master notes. CONCENTRATION OF INVESTMENTS The Fund may invest more than 25% of the value of its assets in industrial development bonds, with no more than 25% of total assets in a single industry. The Fund may also invest more than 25% of the value of its total assets in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, or instruments secured by these instruments, i.e., repurchase agreements. MUNICIPAL BONDS Municipal bonds are debt obligations issued by a state or local entity. The funds raised may support a government's general financial needs or special projects such as housing projects or sewer works. The two principal classifications of municipal bonds are "general obligation" and "revenue" bonds. General obligation bonds are secured by the issuer's pledge of its full faith and credit and taxing power for the payment of principal and interest. Revenue bonds are paid off only with the revenue generated by the project financed by the bond or other specified sources of revenue. For example, in the case of a bridge project, proceeds from the tolls would go directly to retiring the bond issue. Thus, unlike general obligation bonds, revenue bonds do not represent a pledge of credit or create any debt of or charge against the general revenues of a municipality or public authority. FIRST UNION TREASURY MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Stability of principal and current income consistent with stability of principal. Invests in: Short-term U.S. Treasury obligations. Suitable for: Conservative investors seeking high current yields plus relative safety. Key Benefit: A reasonable means of maximizing opportunities and minimizing risks resulting from changing interest rates. DESCRIPTION OF THE FUND First Union Treasury Money Market Fund seeks to provide stability of principal and current income consistent with stability of principal by investing in a portfolio consisting exclusively of short-term U.S. Treasury obligations with an average dollar-weighted maturity of 90 days or less. As a matter of investment strategy which can be changed without shareholder approval, the Adviser intends to maintain a dollar- weighted average maturity for the Fund of 60 days or less. TYPES OF INVESTMENTS The short-term U.S. Treasury obligations in which the Fund invests are issued by the U.S. government and are fully guaranteed as to principal and interest by the United States. They mature in 397 days or less from the date of acquisition unless they are purchased under an agreement that provides for repurchase by the seller within 397 days from the date of acquisition. The Fund may also retain Fund assets in cash. OTHER - ------------------------- ------------------------- - ------------------------- ------------------------- INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. REGULATORY COMPLIANCE Money market mutual funds are subject to Rule 2a-7 (the "Rule") under the Investment Company Act of 1940 which imposes certain risk limiting conditions on the Funds, including: Portfolio investments of each Fund must have a maturity of 397 days or less from the time of acquisition, with the exception of repurchase agreement securities and certain adjustable interest rate instruments. The dollar- weighted average maturity of each Fund's portfolio must not exceed 90 days. The Funds must limit their investments to "eligible securities," i.e., those which (i) have a short-term rating in one of the two highest categories from an NRSRO, (ii) are comparable in priority and security to other short-term debt of the same issuer which already has a short-term rating in one of the two highest categories, or (iii) are unrated by an NRSRO but are of comparable quality. The Funds may invest without limit in "first tier securities," i.e. eligible securities which have (or are comparable to other short-term debt of the same issuer having) the highest short-term rating by any two NRSROs (or, if only one NRSRO has issued a rating with respect to such security, it must be the highest short-term rating given by such NRSRO). Each Fund (except the Tax Free Money Market Fund) must limit investments in "second tier securities" (any eligible security which is not first tier) to 5% of total assets and 1% of total assets in the securities of a single second tier issuer. REPURCHASE AGREEMENTS Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date (usually within 397 days from the date of acquisition). The repurchase price reflects an agreed- upon interest rate for the time period of the agreement. The Fund's risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Fund to sell the security in the open market in the case of a default. In such a case, the Fund may incur costs in disposing of the security which would increase Fund expenses. The Money Market and Tax Free Money Market Funds currently invest in repurchase agreements maturing in seven days or less. The Treasury Money Market Fund also invests in repurchase agreements but will not invest in reverse repurchase agreements. The Adviser will monitor creditworthiness of the firms with which the Funds enter into repurchase agreements. STANDBY COMMITMENTS For liquidity purposes, the Tax Free Money Market Fund may purchase municipal securities accompanied by commitments by the seller to repurchase such securities for the amortized value of those securities. The cost of municipal securities accompanied by these standby commitments could be greater than the cost of municipal securities without such commitments. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which a Fund purchases securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause a Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, a Fund may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Money Market and the Tax Free Money Market Funds may lend portfolio securities on a short-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, neither the Money Market Fund nor the Tax Free Money Market Fund will lend any of its assets except portfolio securities up to 15% of the value of its total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies that have investment objectives and policies similar to its own. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) the Funds will not own more than 3% of the total outstanding voting stock of any one investment company, (2) the Funds may not invest more than 5% of their total assets in any one investment company and (3) the Funds may not invest more than 10% of their total assets in investment companies in general. The following investment limitations cannot be changed without shareholder approval. RESTRICTED AND ILLIQUID SECURITIES The Money Market and Tax Free Money Market Funds may invest up to 10% of their net assets in securities which are subject to restrictions on resale under federal securities laws. With respect to the Money Market Fund, this restriction is not applicable to commercial paper issued under Section 4(2) of the Securities Act of 1933. The Money Market and Tax Free Money Market Funds may invest up to 10% of their net assets in illiquid securities, which include restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. BORROWING MONEY The Money Market and Tax Free Money Market Funds will not borrow money directly or through reverse repurchase agreements, or pledge securities, except under certain circumstances, such Funds may borrow up to one-third of the value of their total assets and pledge up to 15% of the value of those assets to secure such borrowings. The Treasury Money Market Fund will not borrow money directly or pledge securities except, under certain circumstances, the Fund may borrow money in amounts up to one-third of the value of its total assets and pledge up to 10% of the value of its total assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of their total assets, the Money Market and Tax Free Money Market Funds will invest no more than 5% of their total assets in securities of one issuer (except cash, cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. A Fund will invest more than 5% of its assets in any one issuer only under circumstances permitted by the Rule. For the Treasury Money Market Fund, the following limitations can be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective: ILLIQUID OBLIGATIONS The Treasury Money Market Fund will not commit more than 10% of its net assets to illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice. REVERSE REPURCHASE AGREEMENTS The Treasury Money Market Fund will not invest in reverse repurchase agreements. Although not a fundamental restriction or policy requiring a shareholders' vote to change, the Money Market and the Tax Free Money Market Funds have undertaken to a state securities authority that so long as the state authority requires and shares of the Funds are registered for sale in that state, the Funds will not invest in the following: WARRANTS The Money Market and Tax Free Money Market Funds will not invest more than 5% of their net assets in warrants. No more than 2% of this 5% will be in warrants which are not listed on the New York or American Stock Exchanges. SHAREHOLDER GUIDE - ------------------------- ------------------------- - ------------------------- ------------------------- SHARE PRICE CALCULATION The goal of the First Union Money Market Funds is to maintain a net asset value of $1.00 per Share. Purchases, redemptions, and exchanges are made at net asset value. There is no sales charge for any of the First Union Money Market Funds. The Funds attempt to stabilize the net asset value of Shares at $1.00 by valuing the portfolio securities using the amortized cost method of valuation. The net asset value is determined at 12:00 p.m. and 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares (and Class B Shares for the Money Market Fund) of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of the Class B Shares for the Money Market Fund) for each class of shares. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return, effective yield or tax equivalent yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Y Shares. It is generally reported with one or more of the following measures: total return, yield, effective yield or tax equivalent yield (for the Tax Free Money Market Fund). Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much annualized dividend income an investment generates over a seven-day stated period, expressed as a percentage of the investment. The effective yield is calculated similarly to the yield, but the income earned is compounded daily. The Tax Free Money Market Fund may advertise the tax equivalent yield, which is calculated like the yield described above, except that it is adjusted to reflect the taxable yield that the Fund would have had to earn to equal its actual yield, assuming a specific tax rate. The yield and tax equivalent yield do not necessarily reflect income actually earned by Y Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return, yield, effective yield, and tax equivalent yield will be calculated separately for Y Shares, Class A Shares, and Class B Shares (for the Money Market Fund) of a Fund. Because Class A Shares are subject to a Rule 12b- 1 fee, and Class B Shares (for the Money Market Fund) are subject to a Rule 12b-1 fee and a shareholder services fee, the yield, effective yield, and tax equivalent yield will be lower than that of Y Shares. Class B Shares are subject to non-recurring charges, such as the contingent deferred sales charge ("CDSC"), which, if excluded, would increase the total return for Class B Shares. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY SHARES - ------------------------- ------------------------- - ------------------------- ------------------------- Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There are no sales charges imposed on Y Shares of the Funds. However, there is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Capital Management Group of First Union at 1- 800-326-2584. Subsequent investments may be in any amounts. BY TELEPHONE You may purchase Y Shares by telephone from the Capital Management Group of First Union at 1-800-326-2584. (Texas residents should directly contact the Mutual Funds Group of First Union Brokerage Services, Inc. at 1-800-326-3241.) Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. Purchase orders must be received by 4:00 p.m. (Eastern time). Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT - ----------------------- ----------------------- - ----------------------- ----------------------- FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call First Union at 1-800-326-2584 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Y Shares of one First Union Fund for Y Shares of any other First Union Fund by calling toll free 1-800-326-2584 or by writing to First Union. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the shares already owned will be redeemed at current net asset value and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO - ------------------------- ------------------------- - ------------------------- ------------------------- REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any fees. You may redeem Shares in person or by telephoning First Union at 1-800-326-2584 or by written request to First Union. There is no redemption fee charged. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. MANAGEMENT OF - ------------------------- ------------------------- - ------------------------- ------------------------- FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. FUND ADMINISTRATION Federated Securities Corp., Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES - ------------------------- ------------------------- - ------------------------- ------------------------- Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.35 of 1% of each of the Money Market Fund's average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Administrative Fee Net Assets of the Trust - ------------------ ----------------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND Y SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares and Class B Shares (for the Money Market Fund). In addition, the Fund's expenses under a shareholder services plan are incurred solely by the Class B Shares (for the Money Market Fund). The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal, and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND - ------------------------- ------------------------- - ------------------------- ------------------------- PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 7, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 13,305,359 shares (98.98%) of Money Market Fund - Y Shares; 52,762,889 shares (99.99%) of Tax Free Money Market Fund - Y Shares; and 198,311,100 shares (99.99%) of Treasury Money Market Fund - Y Shares, and therefore, may for certain purposes, be deemed to control the Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As of February 7, 1995, First Union National Bank of Florida, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 186,576,376 shares (35.20%) of Tax Free Money Market Fund - A Shares; and 247,971,009 shares (30.57%) of Treasury Money Market Fund - A Shares, and therefore, may for certain purposes, be deemed to control the Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS - ------------------------- ------------------------- - ------------------------- ------------------------- AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared daily and paid monthly for the First Union Money Market Funds. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or First Union in writing. CAPITAL GAINS If any of the Funds experience capital gains, it could result in an increase in dividends for that Fund. Capital losses could result in a decrease in dividends for that Fund. If, for some extraordinary reason, any of the Funds realize long-term capital gains, the Fund will distribute them at least once every 12 months. TAX INFORMATION - ------------------------ ------------------------ - ------------------------ ------------------------ Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Except as set forth under "Tax Free Money Market Fund Additional Tax Information," all shareholders, unless otherwise exempt, are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. TAX FREE MONEY MARKET FUND ADDITIONAL TAX INFORMATION Shareholders of the Tax Free Money Market Fund are not required to pay the federal regular income tax on any dividends received from the Fund that represent net interest on tax-exempt municipal bonds. However, under the Tax Reform Act of 1986, dividends representing net interest earned on some municipal bonds may be included in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The alternative minimum tax, up to 28% of alternative minimum taxable income for individuals and 20% for corporations, applies when it exceeds the regular tax for the taxable year. Alternative minimum taxable income is equal to the adjusted income of the taxpayer increased by certain "tax preference" items not included in regular taxable income and reduced by only a portion of the deductions allowed in the calculation of the regular tax. The Tax Reform Act of 1986 treats interest on certain "private activity" bonds issued after August 7, 1986, as a tax preference item. Unlike traditional governmental purpose municipal bonds, which finance roads, schools, libraries, prisons and other public facilities, private activity bonds provide benefits to private parties. The Fund may purchase all types of municipal bonds, including "private activity" bonds. Thus, should the Fund purchase any such bonds, a portion of the Fund's dividends may be treated as a tax preference item. In addition, in the case of a corporate shareholder, dividends of the Fund which represent interest on municipal bonds may be subject to the 20% corporate alternative minimum tax because the dividends are included in a corporation's "adjusted current earnings." The corporate alternative minimum tax treats 75% of the excess of a taxpayer's pre-tax "adjusted current earnings" over the taxpayer's alternative minimum taxable income as a tax preference item. "Adjusted current earnings" is based upon the concept of a corporation's "earnings and profits." Since "earnings and profits" generally includes the full amount of any Fund dividend, and alternative minimum taxable income does not include the portion of the Fund's dividend attributable to municipal bonds which are not private activity bonds, the difference will be included in the calculation of the corporation's alternative minimum tax. Shareholders are urged to consult their own tax advisers to determine whether they are subject to alternative minimum tax or the corporate alternative minimum tax and, if so, the tax treatment of dividends paid by the Fund. Dividends of the Fund representing net interest income earned on some temporary investments and any realized net short-term gains are taxed as ordinary income. These tax consequences apply whether dividends are received in cash or as additional Shares. Information on the tax status of dividends and distributions is provided annually. OTHER CLASSES - ------------------------ ------------------------ - ------------------------ ------------------------ OF SHARES Tax Free Money Market Fund and Treasury Money Market Fund offer two classes of shares: Y Shares and Class A Shares. In addition, Money Market Fund offers three classes of shares: Y Shares, Class A Shares, and Class B Shares. Y Shares are designed for institutional investors, and Class A Shares and Class B Shares are sold to individuals and other customers of First Union. Class A Shares of the Funds (and Class B Shares of the Money Market Fund) are sold to customers of First Union and others at net asset value with a minimum initial investment of $1,000. Class B Shares may impose a sales charge on a contingent deferred basis. Class A and Class B Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of 0.35 of 1% for Class A Shares and 0.75 of 1% for Class B Shares of the Money Market Fund's average daily net asset value. In addition, Class B Shares pay a shareholder services fee of 0.25 of 1% of the class' average daily net assets. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares and Class B Shares (for the Money Market Fund) will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER - ------------------------ ------------------------ - ------------------------ ------------------------ REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either contact the Capital Management Group of First Union at 1-800-326-2584, or write the Trust. ADDRESSES - ------------------------- ------------------------- - ------------------------- ------------------------- - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] Federated Securities Corp., Distributor 535669 (10/pkg.) G00850-01 (2/95) PROSPECTUS FIRST UNION MONEY MARKET FUNDS CLASS A AND B INVESTMENT SHARES FEBRUARY 28, 1995 FIRST UNION MONEY MARKET FUNDS Portfolios of First Union Funds - ------------------------ ------------------------ - ------------------------ ------------------------ CLASS A INVESTMENT SHARESCLASS B INVESTMENT SHARES - ------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes three diversified Money Market Funds, three diversified Income Funds, three diversified Growth and Income Funds, two diversified Growth Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Money Market Funds .First Union Money Market Portfolio; .First Union Tax Free Money Market Portfolio; and .First Union Treasury Money Market Portfolio. Income Funds .First Union Fixed Income Portfolio; .First Union Managed Bond Portfolio; and .First Union U.S. Government Portfolio. Growth and Income Funds .First Union Balanced Portfolio; .First Union Utility Portfolio; and .First Union Value Portfolio. Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Class A Investment Shares ("Class A Shares") and Class B Investment Shares (for the First Union Money Market Portfolio) ("Class B Shares") (collectively referred to as "Investment Shares") of First Union Money Market Funds. It concisely describes the information which you should know before investing in Class A Shares of any of the First Union Money Market Funds and Class B Shares of the First Union Money Market Portfolio. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Money Market Fund in its Statement of Additional Information, dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statements are available free of charge by writing to First Union Funds, Federated Investors Tower, Pitts- burgh, PA 15222-3779 or by calling 1-800-326-3241. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corpora- tion, the Federal Reserve Board, or any other govern- ment agency. First Union Money Market Funds attempt to maintain a stable net asset value of $1.00 per share; there can be no assurance that the First Union Money Market Funds will be able to do so. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF - ------------------------ ------------------------ - ------------------------ ------------------------ CONTENTS Summary 2 How to Redeem Shares 18 - ------------------------------------- --------------------------------------- Summary of Fund Expenses 3 Additional Shareholder Services 19 - ------------------------------------- --------------------------------------- Financial Highlights 5 Management of First Union Funds 19 - ------------------------------------- --------------------------------------- Investment Objectives and Policies 9 Fees and Expenses 21 - ------------------------------------- --------------------------------------- First Union Money Market Portfolio 9 Shareholder Rights and Privileges 22 - ------------------------------------- --------------------------------------- First Union Tax Free Money Market Distributions and Taxes 23 Portfolio 10 --------------------------------------- - ------------------------------------- Tax Information 23 First Union Treasury Money Market --------------------------------------- Portfolio 12 - ------------------------------------- Other Classes of Shares 24 --------------------------------------- Other Investment Policies 12 - ------------------------------------- Shareholder Reports 24 --------------------------------------- Shareholder Guide 14 - ------------------------------------- Addresses 25 --------------------------------------- How to Buy Shares 16 - ------------------------------------- How to Convert Your Investment from One First Union Fund to Another First Union Fund__________________17 - ------------------------------------- SUMMARY - ------------------------ ------------------------ - ------------------------ ------------------------ DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. First Union Tax Free Money Market Portfolio and First Union Treasury Money Market Portfolio are divided into two classes of shares: Y Shares and Class A Shares. In addition, First Union Money Market Portfolio offers three classes of shares: Class A Shares, Class B Shares, and Y Shares. Class A and Class B Shares are sold to individuals and other customers of First Union (the "Adviser") and are sold at net asset value. Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates only to Class A Investment Shares and Class B Investment Shares (individually or collectively referred to as "Shares") of First Union Money Market Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following three Money Market Funds: . First Union Money Market Portfolio ("Money Market Fund")--seeks to provide current income from short-term securities while preserving capital and maintaining liquidity; . First Union Tax Free Money Market Portfolio ("Tax Free Money Market Fund")-- seeks to provide current income exempt from federal regular income tax, while preserving capital and maintaining liquidity; and . First Union Treasury Money Market Portfolio ("Treasury Money Market Fund")-- seeks to achieve stability of principal and current income consistent with stability of principal. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. PURCHASING AND REDEEMING SHARES For information on purchasing Class A Shares and Class B Shares of any of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION MONEY MARKET FUNDS CLASS A SHARES
Tax Free Treasury Money Money Money Market Market Market Fund Fund Fund ------ ------ -------- Class A Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price).................... None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................... None None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable)................. None None None Redemption Fee (as a percentage of amount redeemed, if applicable)............................................ None None None Exchange Fee............................................ None None None Annual Class A Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1)....................... 0.13% 0.26% 0.17% 12b-1 Fees (after waiver) (2)........................... 0.20% 0.30% 0.30% Total Other Expenses.................................... 0.35% 0.13% 0.13% Total Class A Shares Operating Expenses (3)......... 0.68% 0.69% 0.60%
(1) The management fees have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee is 0.35%. (2) The Funds can pay up to 0.35 of 1% of Class A Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit 12b-1 payments to 0.30 of 1%. The distributor may terminate its voluntary waiver on Money Market Fund at any time at its sole discretion. (3) The Total Class A Shares Operating Expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds were 0.61%, 0.61% and 0.50%, respectively, for the fiscal year ended December 31, 1994. Total Class A Shares Operating Expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds, absent the voluntary waivers of the management fee by the Adviser and waiver of the 12b-1 fee were 0.98%, 0.79% and 0.78%, respectively, for the fiscal year ended December 31, 1994. The Annual Class A Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The total Class A Shares expected operating expenses for Money Market, Tax Free Money Market and Treasury Money Market Funds would be 1.00%, 0.78% and 0.78%, respectively, absent the voluntary waivers described above in notes 1 and 2. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales load permitted under the rules of the National Association of Securities Dealers, Inc. However, in order for a Fund investor to exceed the NASD's maximum front-end sales load of 6.25%, a continuous investment in either Tax Free Money Market or Treasury Money Market Funds for 125 years would be required. EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Class A Shares. Money Market Fund........................... $7 $22 $38 $85 Tax Free Money Market Fund.................. $7 $22 $38 $86 Treasury Money Market Fund.................. $6 $19 $33 $75 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The information set forth in the foregoing table and example relates only to Class A Shares of the Funds. The Money Market Fund also offers two additional classes of shares, called Y Shares and Class B Shares. The Tax Free Money Market Fund and the Treasury Money Market Fund also offer an additional class of shares called Y Shares. Y Shares bear no sales load or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. See "Other Classes of Shares." SUMMARY OF - ------------------------ ------------------------ - ------------------------ ------------------------ FUND EXPENSES FIRST UNION MONEY MARKET PORTFOLIO CLASS B SHARES Class B Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)............ None Maximum Sales Load Imposed on Reinvested Divi- dends (as a percentage of offering price)............ None Contingent Deferred Sales Charge (as a percentage of original purchase price or 5% during the first year, redemption proceeds, as applicable) (1)........ 4% during the second year, 3% during the third year, 3% during the fourth year, 2% during the fifth year, 1% during the sixth year, 1% during the seventh year, and 0% after the seventh year Redemption Fees (as a percentage of amount re- deemed, if applicable)......................... None Exchange Fee.................................... None Annual Class B Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (2)............... 0.13% 12b-1 Fees...................................... 0.75% Total Other Expenses............................ 0.60% Shareholder Service Fee (3).................... 0.25% Total Class B Shares Operating Expenses (4). 1.48% (1) No contingent deferred sales charge is imposed on (a) Shares purchased more than seven years prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per Share. (2) The management fee has been reduced to reflect the voluntary waiver by the Adviser. The Adviser may terminate this voluntary waiver at any time at its sole discretion. The maximum management fee is 0.35%. (3) The Fund began accruing Shareholder Service Fees in September, 1994 at the maximum rate of 0.25%. The Shareholder Service Fee amounted to 0.14% for the fiscal year ended December 31, 1994. (4) The Total Class B Shares Operating Expenses were 1.30% for the fiscal year ended December 31, 1994. Total Class B Shares Operating Expenses, absent the voluntary waiver of the management fee by the Adviser, would have been 1.56% for the fiscal year ended December 31, 1994. The Annual Class B Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The total Class B shares expected operating expenses would be 1.70% absent the voluntary waiver described above in note 2. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Fund will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc ("NASD"). However, in order for a Fund investor to exceed the NASD's maximum front-end sales load of 6.25%, a continuous investment in the Fund for 8.3 years would be required. EXAMPLE 1 year 3 years 5 years 10 years - ------- ------ ------- ------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each time period........................ $67 $80 $105 $177 You would pay the following expenses on the same investment, assuming no redemptions....... $15 $47 $81 $177 The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The example for Class B Shares is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class B Shares of the Fund. The Fund also offers two additional classes of shares called Y Shares and Class A Shares. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class A Shares are subject to a 12b-1 fee of 0.35 of 1% and bear no sales load or shareholder service fee. See "Other Classes of Shares." FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Class B Investment Class A Investment Shares Shares --------------------------------------------------------------- ------------ Year Ended Year Ended Year Ended December 31, March 31, December 31, ------------------------------------------- --------------- ------------ 1994 1993 1992 1991 1990* 1990 1989** 1994*** - ------------------------ ------- ------- ------- ------- ------- ------- ------ ------------ Net asset value, begin- ning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.04 0.03 0.03 0.05 0.06 0.09 0.02 0.03 - ------------------------ ------- ------- ------- ------- ------- ------- ------ ------- Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.04) (0.03) (0.03) (0.05) (0.06) (0.09) (0.02) (0.03) - ------------------------ ------- ------- ------- ------- ------- ------- ------ ------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ------------------------ ------- ------- ------- ------- ------- ------- ------ ------- Total return+ 3.81% 2.83% 3.24% 5.68% 6.07% 8.96% 2.12% 2.79% - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 0.61% 0.62% 0.82% 0.73% 0.42%(b) 0.35% 0.35%(b) 1.30%(b) - ------------------------ Net investment income 3.79% 2.81% 3.18% 5.45% 7.85%(b) 8.50% 8.85%(b) 3.63%(b) - ------------------------ Expense waiver/reimbursement (a) 0.37% 0.39% 0.24% 0.33% 0.66%(b) 0.51% 0.23%(b) 0.26%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of period (000 omitted) $95,760 $88,171 $64,794 $64,457 $32,216 $21,898 $6,850 $11,722 - ------------------------
* Nine months ended December 31, 1990. ** Reflects operations for the period from January 3, 1989 (commmencement of operations) to March 31, 1989. *** Reflects operations for the period from February 28, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Y Shares ------------------------------- Year Ended December 31, ------------------------------- 1994 1993 1992 1991* - ---------------------------------------- ------- ------ ------ ------ Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------------------------- Income from investment operations - ---------------------------------------- Net investment income 0.04 0.03 0.03 0.06 - ---------------------------------------- ------ ------ ------ ------ Less distributions - ---------------------------------------- Dividends to shareholders from net in- (0.04) (0.03) (0.03) (0.06) vestment income ------ ------ ------ ------ - ---------------------------------------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------------------------- ------ ------ ------ ------ Total return+ 4.02% 2.99% 3.43% 5.91% - ---------------------------------------- Ratios to Average Net Assets - ---------------------------------------- Expenses 0.41% 0.47% 0.64% 0.58%(b) - ---------------------------------------- Net investment income 3.99% 2.96% 3.34% 5.24%(b) - ---------------------------------------- Expense waiver/ reimbursement (a) 0.27% 0.24% 0.11% 0.26%(b) - ---------------------------------------- Supplemental Data - ---------------------------------------- Net assets, end of period (000 omitted) $10,403 $9,115 $9,243 $5,550 - ----------------------------------------
* Reflects operations for the period from January 3, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. FINANCIAL - ------------------------ ------------------------ - ------------------------ ------------------------ HIGHLIGHTS First Union Tax Free Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Class A Investment Shares ------------------------------------------------------------------- Year Ended Year Ended December 31, March 31, ---------------------------------------------- ---------------- 1994 1993 1992 1991 1990* 1990 1989** - ---------------------- -------- -------- -------- ------- ------- ------- ------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------- Income from investment operations - ---------------------- Net investment income 0.03 0.02 0.03 0.04 0.04 0.06 0.01 - ---------------------- -------- -------- -------- ------- ------- ------- ------- Less distributions - ---------------------- Dividends to shareholders from net investment income (0.03) (0.02) (0.03) (0.04) (0.04) (0.06) (0.01) - ---------------------- -------- -------- -------- ------- ------- ------- ------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ---------------------- -------- -------- -------- ------- ------- ------- ------- Total return+ 2.61% 2.16% 2.57% 4.20% 4.17% 3.81% 1.28% - ---------------------- Ratios to Average Net Assets - ---------------------- Expenses 0.61% 0.52% 0.69% 0.77% 0.65%(b) 0.65% 0.89%(b) - ---------------------- Net investment income 2.60% 2.16% 2.51% 4.09% 5.45%(b) 5.71% 5.53%(b) - ---------------------- Expense waiver/ reimbursement (a) 0.18% 0.30% 0.20% 0.22% 0.19%(b) 0.06% 0.00%(b) - ---------------------- Supplemental Data - ---------------------- Net assets, end of period (000 omitted) $395,612 $278,451 $184,211 $86,481 $48,603 $36,688 $37,207 - ---------------------- Y Shares ------------------------------------- Year Ended December 31, ------------------------------------- 1994 1993 1992 1991*** - ----------------------- -------- ------- -------- ----------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ----------------------- Income from investment operations - ----------------------- Net investment income 0.03 0.02 0.03 0.01 - ----------------------- -------- ------- -------- ----------- Less distributions - ----------------------- Dividends to shareholders from net investment income (0.03) (0.02) (0.03) (0.01) - ----------------------- -------- ------- -------- ----------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ----------------------- -------- ------- -------- ----------- Total return+ 2.91% 2.38% 2.78% 4.49% - ----------------------- Ratios to Average Net Assets - ----------------------- Expenses 0.31% 0.29% 0.51% 0.63%(b) - ----------------------- Net investment income 2.90% 2.37% 2.76% 4.30%(b) - ----------------------- Expense waiver/ reimbursement (a) 0.18% 0.24% 0.09% 0.22%(b) - ----------------------- Supplemental Data - ----------------------- Net assets, end of period (000 omitted) $20,636 $3,377 $17,084 $37,546 - -----------------------
* Nine months ended December 31, 1990. ** Reflects operations for the period from January 3, 1989 (commencement of operations) to March 31, 1989. *** Reflects operations for the period from January 3, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (b) Computed on an annualized basis. FINANCIAL - ------------------------- ------------------------- - ------------------------- ------------------------- HIGHLIGHTS First Union Treasury Money Market Portfolio (For a share outstanding throughout each period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Money Market Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Money Market Funds' Annual Report, which may be obtained from the Fund.
Class A Investment Shares Y Shares ------------------------------------ -------------------------------------- Year Ended December 31, Year Ended December 31, ------------------------------------ -------------------------------------- 1994 1993 1992 1991* 1994 1993 1992 1991* - ----------------------- -------- -------- -------- ------- -------- -------- -------- -------- Net asset value, beginning of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ----------------------- Income from investment operations - ----------------------- Net investment income 0.04 0.03 0.03 0.04 0.04 0.03 0.04 0.05 - ----------------------- -------- -------- -------- ------- -------- -------- -------- -------- Less distributions - ----------------------- Dividends to shareholders from net investment income (0.04) (0.03) (0.03) (0.04) (0.04) (0.03) (0.04) (0.05) - ----------------------- -------- -------- -------- ------- -------- -------- -------- -------- Net asset value, end of period $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00 - ----------------------- -------- -------- -------- ------- -------- -------- -------- -------- Total return+ 3.75% 2.73% 3.36% 4.46% 4.06% 3.04% 3.67% 4.66% - ----------------------- Ratios to Average Net Assets - ----------------------- Expenses 0.50% 0.48% 0.48% 0.47%(b) 0.20% 0.18% 0.17% 0.20%(b) - ----------------------- Net investment income 3.91% 2.70% 3.22% 4.95%(b) 3.78% 3.00% 3.61% 5.53%(b) - ----------------------- Expense waiver/ reimbursement (a) 0.28% 0.34% 0.34% 0.61%(b) 0.28% 0.34% 0.35% 0.32%(b) - ----------------------- Supplemental Data - ----------------------- Net assets, end of period (000 omitted) $755,050 $261,475 $208,792 $99,549 $162,921 $366,109 $286,230 $265,109 - -----------------------
* Reflects operations for the period from March 6, 1991 (commencement of operations) to December 31, 1991. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. INVESTMENT OBJECTIVES - ------------------------- ------------------------- - ------------------------- ------------------------- AND POLICIES First Union Money Market Funds provide a range of objectives and policies intended to provide current income while preserving capital and maintaining liquidity. The investment objectives and policies of each Fund are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Current income from short-term securities while preserving capital and maintaining liquidity. Invests in: High quality money market instruments. Suitable for: Conservative investors looking for a cash-equivalent investment. Key Benefit: Safety of principal with a generally better yield than passbook savings accounts. DESCRIPTION OF THE FUND First Union Money Market Fund seeks to provide current income from short-term securities while preserving capital and maintaining liquidity. The Fund invests exclusively in a portfolio of high quality money market instruments maturing in 397 days or less, with an average dollar-weighted maturity of 90 days or less. TYPES OF INVESTMENTS The Fund invests in high quality money market instruments that are rated in the highest short-term rating category by major rating organizations (referred to as "NRSROs" or "nationally recognized statistical rating organizations"), such as Standard & Poor's Ratings Group ("S&P") or Moody's Investors Service, Inc. ("Moody's"), or are of comparable quality to securities having such ratings. Examples of these instruments include, but are not limited to: commercial paper; variable amount demand master notes (a borrowing arrangement between a commercial paper issuer (borrower) and an institutional lender such as the Fund which is payable upon demand. The underlying amount of the loan may vary during the course of the contract, as may the interest on the outstanding amount, depending on a stated short-term interest rate index.); instruments of domestic banks and foreign banks (such as certificates of deposit, demand and time deposits, saving shares, and bankers' acceptances) if they have capital, surplus, and undivided profits of over $100,000,000 and/or if their deposits are insured by the Federal Deposit Insurance Corporation ("FDIC"). These instruments may include Eurodollar Certificates of Deposit ("ECDs"), Yankee Certificates of Deposit ("Yankee CDs"), and Eurodollar Time Deposits ("ETDs"), all of which are U.S. dollar denominated; marketable obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities, including these obligations purchased on a when-issued or delayed delivery basis; corporate obligations; and repurchase agreements and reverse repurchase agreements for securities listed above and instruments secured by obligations described above. CONCENTRATION OF INVESTMENTS The Fund may invest more than 25% of its total assets in commercial paper issued by commercial or consumer finance companies. The Fund may also invest more than 25% of the value of its total assets in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, or instruments secured by these money market instruments, i.e., repurchase agreements. RISK FACTORS ECDs, ETDs, and Yankee CDs are subject to different risks than domestic obligations of domestic banks or corporations. Examples of these risks include international, economic and political developments, foreign governmental restrictions that may adversely affect the payment of principal or interest, foreign withholdings or other taxes on interest income, difficulties in obtaining or enforcing a judgment against the issuing entity, and the possible impact of interruptions in the flow of international currency transactions. Different risks may also exist for ECDs, ETDs, and Yankee CDs because the banks issuing these instruments, or their domestic or foreign branches, are not necessarily subject to the same regulatory requirements that apply to domestic banks, such as reserve requirements, loan limitations, examinations, accounting, auditing, and recordkeeping, and the public availability of information. These factors will be carefully considered by the Adviser in selecting investments for the Fund. FIRST UNION TAX FREE MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective: Current income exempt from federal regular income tax, while preserving capital and maintaining liquidity. Invests in: A diversified portfolio of short-term municipal securities. Suitable for: Investors seeking tax free monthly income. Key Benefit: Greater diversification and liquidity than can be achieved by purchasing individual municipal securities. DESCRIPTION OF THE FUND First Union Tax Free Money Market Fund seeks to provide current income exempt from federal regular income tax, while preserving capital and maintaining liquidity. The Fund pursues this objective by investing at least 80% of its assets in a diversified portfolio of municipal securities maturing in 397 days or less, with an average dollar-weighted maturity of 90 days or less. As a matter of investment policy which cannot be changed without the approval of shareholders, the Fund will invest its assets so that at least 80% of its annual interest income is exempt from federal income taxes (including the alternative minimum tax). Interest income of the Fund which is exempt from federal regular income tax retains its tax free status when distributed to the Fund's shareholders. TYPES OF INVESTMENTS Municipal bonds are the primary investment of the Fund. Municipal bonds are debt obligations issued by or on behalf of states, territories, and possessions of the United States, including the District of Columbia, and their political subdivisions, agencies, and instrumentalities, the interest from which is exempt from federal regular income tax. In addition, the Fund may buy participation interests in municipal securities. (Participation interests may be purchased from financial institutions such as commercial banks, savings and loan associations and insurance companies and give the Fund an undivided interest in particular municipal securities. The securities which are subject to these participation interests are not limited to maturities of one year or less as long as they include the right to demand payment, typically within seven days, from the issuer.) The municipal securities in which the Fund invests are: bonds rated in the two highest categories by an NRSRO or, if unrated, deemed by the Adviser to be of comparable quality; securities guaranteed at the time of purchase by the U.S. government as to the payment of principal and interest; municipal leases; or notes, tax-exempt commercial paper and variable rate demand obligations rated in the highest category by an NRSRO or if unrated, determined by the Adviser to be of comparable quality. (Variable rate securities offer interest rates which are tied to a money market rate, usually a published interest rate or interest rate index or the 91-day U.S. Treasury bill rate. Many of these securities are subject to prepayment of principal on demand by the Fund, usually in seven days or less. Variable rate municipal securities without the demand feature may not be considered liquid by the Adviser, who will limit investments in illiquid securities to no more than 10% of net assets.) TEMPORARY INVESTMENTS Although the Fund is permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal income tax. During periods when, in the Adviser's opinion, a temporary defensive position in the market is appropriate, the Fund may temporarily invest in short-term money market instruments whose interest income may be taxable to shareholders as ordinary income. These temporary investments include: obligations issued by or on behalf of municipal or corporate issuers having the same quality characteristics as municipal securities purchased by the Fund; marketable obligations issued or guaranteed by the U.S. government, its agencies or instrumentalities; instruments issued by banks or savings and loans which have capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment whose deposits are insured by the Bank Insurance Fund ("BIF") or the Savings Association Insurance Fund ("SAIF") (administered by the FDIC), foreign branches of U.S. banks and U.S. branches of foreign banks; repurchase agreements collateralized by eligible investments; prime commercial paper rated A-1 by S&P or P-1 by Moody's; and variable amount demand master notes. CONCENTRATION OF INVESTMENTS The Fund may invest more than 25% of the value of its assets in industrial development bonds, with no more than 25% of total assets in a single industry. The Fund may also invest more than 25% of the value of its total assets in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities, or instruments secured by these instruments, i.e., repurchase agreements. MUNICIPAL BONDS Municipal bonds are debt obligations issued by a state or local entity. The funds raised may support a government's general financial needs or special projects such as housing projects or sewer works. The two principal classifications of municipal bonds are "general obligation" and "revenue" bonds. General obligation bonds are secured by the issuer's pledge of its full faith and credit and taxing power for the payment of principal and interest. Revenue bonds are paid off only with the revenue generated by the project financed by the bond or other specified sources of revenue. For example, in the case of a bridge project, proceeds from the tolls would go directly to retiring the bond issue. Thus, unlike general obligation bonds, revenue bonds do not represent a pledge of credit or create any debt of or charge against the general revenues of a municipality or public authority. FIRST UNION TREASURY MONEY MARKET - ------------------------- ------------------------- - ------------------------- ------------------------- PORTFOLIO Objective:Stability of principal and current income consistent with stability of principal. Invests in: Short-term U.S. Treasury obligations. Suitable for: Conservative investors seeking high current yields plus relative safety. Key Benefit: A reasonable means of maximizing opportunities and minimizing risks resulting from changing interest rates. DESCRIPTION OF THE FUND First Union Treasury Money Market Fund seeks to provide stability of principal and current income consistent with stability of principal by investing in a portfolio consisting exclusively of short-term U.S. Treasury obligations with an average dollar-weighted maturity of 90 days or less. As a matter of investment strategy which can be changed without shareholder approval, the Adviser intends to maintain a dollar-weighted average maturity for the Fund of 60 days or less. TYPES OF INVESTMENTS The short-term U.S. Treasury obligations in which the Fund invests are issued by the U.S. government and are fully guaranteed as to principal and interest by the United States. They mature in 397 days or less from the date of acquisition unless they are purchased under an agreement that provides for repurchase by the seller within 397 days from the date of acquisition. The Fund may also retain Fund assets in cash. OTHER - ------------------------- ------------------------- - ------------------------- ------------------------- INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. REGULATORY COMPLIANCE Money market mutual funds are subject to Rule 2a-7 (the "Rule") under the Investment Company Act of 1940 which imposes certain risk limiting conditions on the Funds, including: Portfolio investments of each Fund must have a maturity of 397 days or less from the time of acquisition, with the exception of repurchase agreement securities and certain adjustable interest rate instruments. The dollar- weighted average maturity of each Fund's portfolio must not exceed 90 days. The Funds must limit their investments to "eligible securities," i.e., those which (i) have a short-term rating in one of the two highest categories from an NRSRO, (ii) are comparable in priority and security to other short-term debt of the same issuer which already has a short-term rating in one of the two highest categories, or (iii) are unrated by an NRSRO but are of comparable quality. The Funds may invest without limit in "first tier securities," i.e. eligible securities which have (or are comparable to other short-term debt of the same issuer having) the highest short-term rating by any two NRSROs (or, if only one NRSRO has issued a rating with respect to such security, it must be the highest short-term rating given by such NRSRO). Each Fund (except the Tax Free Money Market Fund) must limit investments in "second tier securities" (any eligible security which is not first tier) to 5% of total assets and 1% of total assets in the securities of a single second tier issuer. REPURCHASE AGREEMENTS Repurchase agreements are agreements by which a Fund purchases a security (usually U.S. government securities) for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date (usually within 397 days from the date of acquisition). The repurchase price reflects an agreed- upon interest rate for the time period of the agreement. The Fund's risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Fund to sell the security in the open market in the case of a default. In such a case, the Fund may incur costs in disposing of the security which would increase Fund expenses. The Money Market and Tax Free Money Market Funds currently invest in repurchase agreements maturing in seven days or less. The Treasury Money Market Fund also invests in repurchase agreements but will not invest in reverse repurchase agreements. The Adviser will monitor creditworthiness of the firms with which the Funds enter into repurchase agreements. STANDBY COMMITMENTS For liquidity purposes, the Tax Free Money Market Fund may purchase municipal securities accompanied by commitments by the seller to repurchase such securities for the amortized value of those securities. The cost of municipal securities accompanied by these standby commitments could be greater than the cost of municipal securities without such commitments. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which a Fund purchases securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause a Fund to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, a Fund may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, a Fund may enter into transactions to sell its purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Money Market and the Tax Free Money Market Funds may lend portfolio securities on a short-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. As a matter of fundamental investment policy which cannot be changed without shareholder approval, neither the Money Market Fund nor the Tax Free Money Market Fund will lend any of its assets except portfolio securities up to 15% of the value of its total assets. There is the risk that when lending portfolio securities, the securities may not be available to a Fund on a timely basis and the Fund may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund may invest in the securities of other investment companies that have investment objectives and policies similar to its own. This is a short-term measure to invest cash which has not yet been invested in other portfolio instruments and is subject to the following limitations: (1) the Funds will not own more than 3% of the total outstanding voting stock of any one investment company, (2) the Funds may not invest more than 5% of their total assets in any one investment company and (3) the Funds may not invest more than 10% of their total assets in investment companies in general. The following investment limitations cannot be changed without shareholder approval. RESTRICTED AND ILLIQUID SECURITIES The Money Market and Tax Free Money Market Funds may invest up to 10% of their net assets in securities which are subject to restrictions on resale under federal securities laws. With respect to the Money Market Fund, this restriction is not applicable to commercial paper issued under Section 4(2) of the Securities Act of 1933. The Money Market and Tax Free Money Market Funds may invest up to 10% of their net assets in illiquid securities, which include restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. BORROWING MONEY The Money Market and Tax Free Money Market Funds will not borrow money directly or through reverse repurchase agreements, or pledge securities, except under certain circumstances, such Funds may borrow up to one-third of the value of their total assets and pledge up to 15% of the value of those assets to secure such borrowings. The Treasury Money Market Fund will not borrow money directly or pledge securities except, under certain circumstances, the Fund may borrow money in amounts up to one-third of the value of its total assets and pledge up to 10% of the value of its total assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of their total assets, the Money Market and Tax Free Money Market Funds will invest no more than 5% of their total assets in securities of one issuer (except cash, cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. A Fund will invest more than 5% of its assets in any one issuer only under circumstances permitted by the Rule. For the Treasury Money Market Fund, the following limitations can be changed by the Trustees without shareholder approval. Shareholders will be notified before any material change in these limitations becomes effective: ILLIQUID OBLIGATIONS The Treasury Money Market Fund will not commit more than 10% of its net assets to illiquid obligations, including repurchase agreements providing for settlement in more than seven days after notice. REVERSE REPURCHASE AGREEMENTS The Treasury Money Market Fund will not invest in reverse repurchase agreements. Although not a fundamental restriction or policy requiring a shareholders' vote to change, the Money Market and the Tax Free Money Market Funds have undertaken to a state securities authority that so long as the state authority requires and shares of the Funds are registered for sale in that state, the Funds will not invest in the following: WARRANTS The Money Market and Tax Free Money Market Funds will not invest more than 5% of their net assets in warrants. No more than 2% of this 5% will be in warrants which are not listed on the New York or American Stock Exchanges. SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- GUIDE CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing either Class A Shares or Class B Shares. Your decision will be based on the amount of your intended purchase and how long you expect to hold the Shares. Each Fund offers Class A Investment Shares. The Money Market Fund also offers Class B Investment Shares. Each Share of the Funds represents an identical interest in the investment portfolio of the Funds and has the same rights. The difference between Class A Shares and Class B Shares is based on a contingent deferred sales charge ("CDSC"), shareholder services fees, and distribution expenses. Class A Shares are subject to a lower Rule 12b-1 distribution fee which means that investors in Class A Shares will receive higher dividends per Share. Class B Shares impose a CDSC on most redemptions made within seven years of purchase and have higher distribution costs resulting from greater Rule 12b-1 distribution fees. This means that investors may purchase the same amount of Class B Shares as Class A Shares for the same initial investment, but investors in Class B Shares will receive lower dividends per Share. Investors should consider whether, during the anticipated life of their investment in the Funds, the accumulated shareholder services fee, Rule 12b-1 fee and the CDSC on Class B Shares would be less than the accumulated Rule 12b- 1 fee on Class A Shares purchased at the same time. Investors must also consider how that differential would be offset by the higher yield of Class A Shares. SHARE PRICE CALCULATION The goal of the First Union Money Market Funds is to maintain a net asset value of $1.00 per Share. Purchases, redemptions, and exchanges are all based on net asset value. (The redemption proceeds of Class B Shares deduct an applicable CDSC.) There is no initial sales charge for any of the First Union Money Market Funds. The Funds attempt to stabilize the net asset value of Shares at $1.00 by valuing the portfolio securities using the amortized cost method of valuation. The net asset value is determined at 12:00 p.m. and 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares (and Class B Shares for the Money Market Fund) of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of the Class B Shares for the Money Market Fund) for each class of shares. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return, yield, effective yield, or tax equivalent yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Class A Shares and Class B Shares.It is generally reported with one or more of the following measures: total return, yield, effective yield or tax equivalent yield (for the Tax Free Money Market Fund). Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much annualized dividend income an investment generates over a seven-day period, expressed as a percentage of the investment. The effective yield is calculated similarly to the yield, but the income earned is compounded daily. The Tax Free Money Market Fund may advertise the tax equivalent yield, which is calculated like the yield described above, except that it is adjusted to reflect the taxable yield that the Fund would have had to earn to equal its actual yield, assuming a specific tax rate. The yield and tax equivalent yield do not necessarily reflect income actually earned by Class A Shares and Class B Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return, yield, effective yield, and tax equivalent yield will be calculated separately for Y Shares, Class A Shares, and Class B Shares (for the Money Market Fund) of a Fund. Because Class A Shares are subject to a Rule 12b-1 fee, and Class B Shares (for the Money Market Fund) are subject to a Rule 12b-1 fee and a shareholder services fee, the yield, effective yield, and tax equivalent yield will be lower than that of Y Shares. Class B Shares are subject to non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class B Shares. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO - ------------------------ ------------------------ - ------------------------ ------------------------ BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. Class B Shares (for the Money Market Fund) may impose a sales charge on a contingent deferred basis. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Mutual Funds Group of First Union Brokerage Services ("FUBS"), a subsidiary of First Union, at 1-800-326-3241. Subsequent investments may be in any amounts. WHAT CLASS B SHARES COST Class B Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Class B Shares redeemed within seven years of their purchase will be subject to a CDSC according to the following schedule (applicable only to purchases beginning September 1, 1994): Year of Redemption Contingent Deferred After Purchase Sales Charge - ------------------ ------------------- First 5.0% Second 4.0% Third 3.0% Fourth 3.0% Fifth 2.0% Sixth 1.0% Seventh 1.0% No CDSC will be imposed on: (1) the portion of redemption proceeds attributable to increases in the value of the account due to increases in the net asset value per Share, (2) Shares acquired through reinvestment of dividends and capital gains, (3) Shares held for more than seven years after the end of the calendar month of acquisition, (4) accounts following the death or disability of a shareholder, or (5) minimum required distributions to a shareholder over the age of 70 1/2 from an IRA or other retirement plan. CONVERSION FEATURE OF CLASS B SHARES Class B Shares include all Shares purchased pursuant to the deferred sales charge alternative which have been outstanding for less than the period ending seven years after the end of the month in which the shareholder's order to purchase Class B Shares was accepted. At the end of this seven year period, Class B Shares may automatically convert to Class A Shares (of the Money Market Fund), in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class B Shares. Such conversion will be on the basis of the relative net asset values of the two classes, without the imposition of any sales load, fee, or other charge. The purpose of the conversion feature is to relieve the holders of the Class B Shares that have been outstanding for a period of time sufficient for the distributor to have been compensated for distribution expenses related to the Class B Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class A Shares, Class B Shares purchased through the reinvestment of dividends and distributions paid on Class B Shares in a shareholder's Fund account will be considered to be held in a separate sub- account. Each time any Class B Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class A Shares, an equal pro rata portion of the Class B Shares in the sub-account will also convert to Class A Shares. The availability of the conversion feature is subject to the granting of an exemptive order (the "Order") by the Securities and Exchange Commission (the "SEC") or the adoption of a rule permitting such conversion. In the event that the Order or rule ultimately issued by the SEC requires any conditions additional to those described in this prospectus, shareholders will be notified. BY TELEPHONE OR IN PERSON You may purchase Class A Shares by telephone from the Mutual Funds Group of FUBS at 1-800-326-3241 or you may place the order in person at any First Union branch location. Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. All purchase orders received prior to 4:00 p.m. (Eastern time) on a regular business day are processed at that day's offering price. Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST - ------------------------- ------------------------- - ------------------------- ------------------------- UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call FUBS at 1-800-326-3241 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another First Union Fund, which may produce a gain or loss for tax purposes. You may exchange Class A Shares of one First Union Fund for Class A Shares of any other First Union Fund, or Class B Shares of one First Union Fund for Class B Shares of any other First Union Fund by calling toll free 1-800-326-3241 or by writing to FUBS. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the shares already owned will be redeemed at current net asset value and shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. The exchange of Class B Shares will not be subject to a CDSC. However, if the shareholder redeems Class B Shares within seven years of the original purchase, a CDSC will be imposed. For purposes of computing the CDSC, the length of time the shareholder has owned Class B Shares will be measured from the date of original purchase and will not be affected by the exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO - ------------------------- ------------------------- - ------------------------- ------------------------- REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any applicable CDSC. You may redeem Shares in three ways: (1) by telephoning FUBS at 1-800-326-3241, (2) by written request to FUBS or Federated Services Company, c/o State Street Bank and Trust Company, P.O. Box 8609, Boston, Massachusetts 02266-8609 or (3) in person at First Union. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record, normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. ADDITIONAL SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- SERVICES CHECKWRITING You may establish a checking account through State Street Bank and Trust Company, the Funds' custodian, for redeeming Class A Shares. There is a minimum redemption requirement for each Fund account of $250.00 per check. A check may not be written to close an account. TELEPHONE SERVICES You may authorize electronic transfers of money to purchase Shares in any amount or to redeem any or all Shares in an account. The service may be used like an "electronic check" to move money between a bank account and an account in a Fund with a single telephone call. SYSTEMATIC INVESTMENT PLAN You may arrange for systematic monthly or quarterly investments in your account in amounts of $25 or more by directly debiting your bank account. TAX SHELTERED PLANS You may open a pension and profit sharing account in any First Union Fund (except those First Union Funds having an objective of providing tax free income) including Individual Retirement Accounts ("IRAs"), Rollover IRAs, Keogh Plans, Corporate Profit-Sharing, Pension and Salary-Reduction Plans. For details, including fees and application forms, call First Union toll free at 1- 800-669-2136 or write to First Union National Bank of North Carolina, Retirement Services, 301 South College Street, Charlotte, NC 28288-1169. SYSTEMATIC CASH WITHDRAWAL PLAN When an account of $10,000 or more is opened or when an existing account reaches that size, you may participate in the Fund's Systematic Cash Withdrawal Plan by filling out the appropriate part of the share purchase application. Under this plan, you may receive (or designate a third party to receive) a monthly or quarterly check in a stated amount of not less than $25. Fund Shares will be redeemed as necessary to meet withdrawal payments. All participants must elect to have their dividends and capital gain distributions reinvested automatically. Any applicable Class B Shares CDSC will be waived with respect to redemptions occurring under a Systematic Cash Withdrawal Plan during a calendar year to the extent that such redemptions do not exceed 10% of (i) the initial value of the account, plus (ii) the value, at the time of purchase, of any subsequent investments. MANAGEMENT OF - ------------------------- ------------------------- - ------------------------- ------------------------- FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. DISTRIBUTION OF INVESTMENT SHARES Federated Securities Corp. ("FSC"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Each class of Investment Shares of a Fund has adopted a separate plan for distribution of Shares permitted by Rule 12b-1 under the Investment Company Act of 1940 (the "Plans"), whereby each Fund has authorized a daily expense ("Rule 12b-1 fee") at an annual rate of up to 0.35 of 1% and 0.75 of 1% of the average daily net asset value of that Fund to finance the sale of Class A Shares and Class B Shares, respectively. It is currently intended that annual Rule 12b-1 fees will be limited for the foreseeable future to payments to the distributor equal to 0.30 of 1% for Class A Shares of each Fund's respective average daily net asset value. The distributor may pay all or a portion of the Rule 12b-1 fee to compensate selected brokers and financial institutions for selling Shares or for administrative services rendered in connection with the Shares. The Funds make no payments in connection with the sale of Shares other than the Rule 12b-1 fees paid to the distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class B Shares. Except as set forth in the next paragraph, the Class B Shares (for the Money Market Fund) do not pay for unreimbursed expenses of the distributor. With respect to both classes of Shares, the Funds do not pay for unreimbursed expenses of the distributor. Since the Funds' Plan is a "compensation" type plan, however, future Rule 12b-1 fees may permit recovery of the distributor's expenses or may result in a profit to FSC. With respect to Class B Shares (for the Money Market Fund), the distributor may sell, assign, or pledge its right to receive Rule 12b-1 fees and CDSCs to finance payments made to brokers (including FUBS) in connection with the sale of Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class B Shares at any given time may exceed the Rule 12b-1 fees and payments received pursuant to CDSCs. These unrecovered amounts, plus interest thereon, will be carried forward and paid from future Rule 12b-1 fees and payments received through CDSCs. If the Class B Shares' Plan were terminated or not continued, the Fund would not be contractually obligated to pay for any expenses not previously reimbursed by the Fund or recovered through CDSCs. FSC, from time to time, may pay brokers additional sums of cash or promotional incentives based upon the amount of Shares sold. Such payments, if made, will be in addition to amounts paid under the Plan and will not be an expense of the Funds. FUND ADMINISTRATION Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. The Class B Shares of the Money Market Fund may pay a shareholder servicing agent (the "Shareholder Servicing Agent") a fee based on average daily net asset value for Class B Shares of the Fund for which the Shareholder Servicing Agent provides shareholder services. As such, the Shareholder Servicing Agent provides shareholder services which include, but are not limited to, distributing prospectuses and other information, providing shareholder assistance, and communicating or facilitating purchases and redemptions of Class B Shares. The Fund may pay the Shareholder Servicing Agent a fee equal to 0.25 of 1% of the average daily net asset value of Class B Shares for which the Shareholder Servicing Agent provides shareholder services. The Shareholder Servicing Agent may voluntarily choose to waive all or a portion of its fee at any time. First Union Brokerage Services, First Union, and other financial institutions may serve as Shareholder Servicing Agent. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND - ------------------------- ------------------------- - ------------------------- ------------------------- EXPENSES Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser receives an annual investment advisory fee equal to 0.35 of 1% of each of the Money Market Fund's average daily net assets. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below: Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust - -------------------- ----------------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND INVESTMENT SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of that Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred solely by the Class A Shares and Class B Shares (for the Money Market Fund). In addition, the Fund's expenses under a shareholder services plan are incurred solely by the Class B Shares (for the Money Market Fund). The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND - ------------------------- ------------------------- - ------------------------- ------------------------- PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 7, 1995, First Union National Bank of Florida, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 186,576,376 shares (35.20%) of Tax Free Money Market Fund--A Shares; and 247,971,009 shares (30.57%) of Treasury Money Market Fund--A Shares, and therefore, may for certain purposes, be deemed to control the Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As of February 7, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 13,305,359 shares (98.98%) of Money Market Fund--Y Shares; 52,762,889 shares (99.99%) of Tax Free Money Market Fund--Y Shares; and 198,311,100 shares (99.99%) of Treasury Money Market Fund--Y Shares, and therefore, may for certain purposes, be deemed to control the Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statements of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS - ------------------------- ------------------------- - ------------------------- ------------------------- AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared daily and paid monthly for the First Union Money Market Funds. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex-dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Funds or FUBS in writing. CAPITAL GAINS If any of the Funds experience capital gains, it could result in an increase in dividends for that Fund. Capital losses could result in a decrease in dividends for that Fund. If, for some extraordinary reason, any of the Funds realize long-term capital gains, the Fund will distribute them at least once every 12 months. TAX INFORMATION - ------------------------- ------------------------- - ------------------------- ------------------------- Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended, applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Except as set forth under "Tax Free Money Market Fund Additional Tax Information," all shareholders, unless otherwise exempt, are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Money Market Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. TAX FREE MONEY MARKET FUND ADDITIONAL TAX INFORMATION Shareholders of the Tax Free Money Market Fund are not required to pay the federal regular income tax on any dividends received from the Fund that represent net interest on tax-exempt municipal bonds. However, under the Tax Reform Act of 1986, dividends representing net interest earned on some municipal bonds may be included in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The alternative minimum tax, up to 28% of alternative minimum taxable income for individuals and 20% for corporations, applies when it exceeds the regular tax for the taxable year. Alternative minimum taxable income is equal to the adjusted income of the taxpayer increased by certain "tax preference" items not included in regular taxable income and reduced by only a portion of the deductions allowed in the calculation of the regular tax. The Tax Reform Act of 1986 treats interest on certain "private activity" bonds issued after August 7, 1986, as a tax preference item. Unlike traditional governmental purpose municipal bonds, which finance roads, schools, libraries, prisons, and other public facilities, private activity bonds provide benefits to private parties. The Fund may purchase all types of municipal bonds, including "private activity" bonds. Thus, should the Fund purchase any such bonds, a portion of the Fund's dividends may be treated as a tax preference item. In addition, in the case of a corporate shareholder, dividends of the Fund which represent interest on municipal bonds may be subject to the 20% corporate alternative minimum tax because the dividends are included in a corporation's "adjusted current earnings." The corporate alternative minimum tax treats 75% of the excess of a taxpayer's pre-tax "adjusted current earnings" over the taxpayer's alternative minimum taxable income as a tax preference item. "Adjusted current earnings" is based upon the concept of a corporation's "earnings and profits." Since "earnings and profits" generally includes the full amount of any Fund dividend, and alternative minimum taxable income does not include the portion of the Fund's dividend attributable to municipal bonds which are not private activity bonds, the difference will be included in the calculation of the corporation's alternative minimum tax. Shareholders are urged to consult their own tax advisers to determine whether they are subject to alternative minimum tax or the corporate alternative minimum tax and, if so, the tax treatment of dividends paid by the Fund. Dividends of the Fund representing net interest income earned on some temporary investments and any realized net short-term gains are taxed as ordinary income. These tax consequences apply whether dividends are received in cash or as additional Shares. Information on the tax status of dividends and distributions is provided annually. OTHER CLASSES - ------------------------- ------------------------- - ------------------------- ------------------------- OF SHARES Tax Free Money Market Fund and Treasury Money Market Fund offer two classes of shares: Y Shares and Class A Shares. In addition, Money Market Fund offers three classes of shares: Y Shares, Class A Shares, and Class B Shares. Y Shares are designed for institutional investors and Class A Shares and Class B Shares are sold to individuals and other customers of First Union. Y Shares are sold to accounts for which First Union or other financial institutions act in a fiduciary or agency capacity at net asset value, without a sales charge, at a minimum investment of $1,000. Y Shares are not sold pursuant to a Rule 12b-1 plan. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares and Class B Shares (for the Money Market Fund) will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER - ------------------------- ------------------------- - ------------------------- ------------------------- REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either call FUBS, at 1-800-326- 3241, or write the Trust. ADDRESSES - ------------------------ ------------------------ - ------------------------ ------------------------ - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] G00850-02 (2/95) FEDERATED SECURITIES CORP., DISTRIBUTOR 535673 (20/PKG.) G00850-02 (2/95) FIRST UNION MONEY MARKET PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, or Class B Investment Shares for First Union Money Market Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' or Class B Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 When-Issued and Delayed Delivery Transactions 1 Restricted and Illiquid Securities 1 Section 4(2) Commercial Paper 2 Concentration of Investments 2 Lending of Portfolio Securities 2 Reverse Repurchase Agreements 2 Investment Limitations 3 FIRST UNION FUNDS MANAGEMENT 4 - --------------------------------------------------------------- Officers and Trustees 4 Fund Ownership 6 Trustees Compensation 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 7 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 8 - --------------------------------------------------------------- Distribution Plans (Class A and Class B Investment Shares) 8 Shareholder Services Plan 9 Conversion to Federal Funds 9 DETERMINING NET ASSET VALUE 9 - --------------------------------------------------------------- Use of the Amortized Cost Method 9 REDEEMING SHARES 10 - --------------------------------------------------------------- Redemption in Kind 10 TAX STATUS 10 - --------------------------------------------------------------- The Fund's Tax Status 10 Shareholders' Tax Status 11 YIELD 11 - --------------------------------------------------------------- EFFECTIVE YIELD 11 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 12 - --------------------------------------------------------------- FINANCIAL STATEMENTS 12 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Money Market Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in three classes: Y Shares, Class A Investment Shares, and Class B Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to seek current income from short-term securities while preserving capital and maintaining liquidity. The investment objective cannot be changed without the approval of shareholders. TYPES OF INVESTMENTS The Fund invests exclusively in high quality money market instruments which mature in 397 days or less, and which include, but are not limited to, commercial paper and variable amount demand master notes, bank instruments, U.S. government obligations, and repurchase agreements. The instruments of banks that are members of the Federal Deposit Insurance Corporation such as certificates of deposit, demand and time deposits, and bankers' acceptances, are not necessarily guaranteed by that organization. U.S. GOVERNMENT OBLIGATIONS The types of U.S. government obligations in which the Fund may invest generally include obligations issued or guaranteed by U.S. government agencies or instrumentalities. These securities are backed by: . the discretionary authority of the U.S. government to purchase certain obligations of agencies or instrumentalities; or . the credit of the agency or instrumentality issuing the obligations. Examples of agencies and instrumentalities which may not always receive financial support from the U.S. government are: . Farm Credit Banks; . Federal Home Loan Banks; . Federal National Mortgage Association; . Student Loan Marketing Association; and . Federal Home Loan Mortgage Corporation. BANK INSTRUMENTS In addition to domestic bank obligations, such as certificates of deposit, demand and time deposits, and bankers' acceptances, the Fund may invest in: . Eurodollar Certificates of Deposit issued by foreign branches of U.S. or foreign banks; . Eurodollar Time Deposits, which are U.S. dollar-denominated deposits in foreign branches of U.S. or foreign banks; . Canadian Time Deposits, which are U.S. dollar-denominated deposits issued by branches of major Canadian banks located in the United States; and . Yankee Certificates of Deposit, which are U.S. dollar-denominated certificates of deposit issued by U.S. branches of foreign banks and held in the United States. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. RESTRICTED AND ILLIQUID SECURITIES The ability of the Trust's Board of Trustees ("Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 ("Rule 144A"). Rule 144A is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. Rule 144A provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. Rule 144A was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: .the frequency of trades and quotes for the security; .the number of dealers willing to purchase or sell the security and the number of other potential buyers; .dealer undertakings to make a market in the security; and .the nature of the security and the nature of the marketplace trades. SECTION 4(2) COMMERCIAL PAPER The Fund may invest in commercial paper issued in reliance on the exemption from registration afforded by Section 4(2) of the Securities Act of 1933. Section 4(2) paper is restricted as to disposition under federal securities laws and is generally sold to institutional investors, such as the Fund, who agree that they are purchasing the paper for investment purposes and not with a view to public distribution. Any resale by the purchaser must be in an exempt transaction. Section 4(2) paper is normally resold to other institutional investors like the Fund through or with the assistance of the issuer or investment dealers who make a market in Section 4(2) commercial paper, thus providing liquidity. CONCENTRATION OF INVESTMENTS The Fund may invest more than 25% of its total assets in commercial paper issued by finance companies. The finance companies in which the Fund intends to invest can be divided into two categories, commercial finance companies and consumer finance companies. Commercial finance companies are principally engaged in lending to corporations or other businesses. Consumer finance companies are primarily engaged in lending to individuals. Captive finance companies or finance subsidiaries which exist to facilitate the marketing and financial activities of their parent will, for purposes of industry concentration, be classified by the Fund in the industry of its parent corporation. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. This transaction is similar to borrowing cash. In a reverse repurchase agreement the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated on the Fund's records at the trade date. These securities are marked to market daily and maintained until the transaction is settled. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes and then only in amounts not in excess of 5% of the value of its total assets or in an amount up to one-third of the value of its total assets, including the amount borrowed, in order to meet redemption requests without immediately selling portfolio instruments. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of the value of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the pledge. RESTRICTED SECURITIES The Fund will not invest more than 10% of its net assets in securities subject to restrictions on resale under the federal securities laws. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. INVESTING IN REAL ESTATE The Fund will not purchase or sell real estate, although it may invest in the securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets, except that it may purchase or hold money market instruments, including repurchase agreements and variable amount demand master notes, in accordance with its investment objective, policies and limitations and lend portfolio securities valued at not more than 15% of its total assets to broker/dealers. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, the Fund will not purchase securities of any one issuer (other than cash, cash items, or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. CONCENTRATION OF INVESTMENTS The Fund will not invest more than 25% of the value of its total assets in any one industry except commercial paper of finance companies. In addition, the Fund may invest more than 25% in cash or cash items, securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities, or instruments secured by these money market instruments (i.e., repurchase agreements). INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of the value of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, non-negotiable fixed time deposits with maturities over seven days, and certain restricted securities not determined by the Trustees to be liquid. The above limitations cannot be changed without shareholder approval. The following investment limitations, however, may be changed by Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 0.5 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of the value of its total assets in securities of unseasoned issuers, including their predecessors, that have been in operation for less than three years. INVESTING IN WARRANTS The Fund will not invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities. To comply with certain state restrictions, the Fund will limit its investment in such warrants not listed on the New York or American Stock Exchanges to 2% of its net assets. For purposes of this investment restriction, warrants acquired by the Fund in units or attached to securities may be deemed to be without value. Although the following limitation is not a fundamental restriction or policy requiring a shareholder vote, the Fund has also undertaken to comply with the following limitation to a state securities authority for as long as the state authority requires and shares of the Fund are registered for sale in that state. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets in the last fiscal year and has no present intent to do so in the coming fiscal year. In addition, the Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank of Charlotte, North Carolina owned approximately 13,305,359 Shares (98.98%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union National Bank of Charlotte, North Carolina owned approximately 10,873,149 Shares (9.50%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: Daniel McEntire Gold of Randleman, North Carolina, owned approximately 699,331 Shares (5.88%). TRUSTEES COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned $372,483, $332,305, and $293,516, of which $283,063, $231,837, and $97,248, were voluntarily waived, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp. ("FSC"), or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .industry studies; .economic studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $0, $0, and $0, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $89,751, $82,912, and $77,362, in administrative service costs, of which $0, $0, and $0, were waived, respectively. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value without a sales charge on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." DISTRIBUTION PLANS (CLASS A AND CLASS B INVESTMENT SHARES) With respect to the Class A and Class B Investment Shares classes of the Fund, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A and Class B Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A and Class B Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A and Class B Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A and Class B Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A and Class B Investment Shares. By adopting the Plans, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $278,313 in distribution services fees on behalf of Class A Investment Shares, of which $92,772 were waived. For the period ended December 31, 1994, the Fund incurred $32,226 in distribution services fees on behalf of Class B Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. SHAREHOLDER SERVICES PLAN For the period ended December 31, 1994, the Fund incurred a shareholder services fee of $5,830 on behalf of Class B Investment Shares. CONVERSION TO FEDERAL FUNDS It is the Fund's policy to be as fully invested as possible so that maximum interest may be earned. To this end, all payments from shareholders must be in federal funds or be converted into federal funds. First Union and the custodian act as the shareholder's agent in depositing checks and converting them to federal funds. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- The Fund attempts to stabilize the value of its Shares at $1.00. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. USE OF THE AMORTIZED COST METHOD The Trustees have decided that the best method for determining the value of portfolio instruments is amortized cost. Under this method, portfolio instruments are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Fund's use of the amortized cost method of valuing portfolio instruments depends on its compliance with certain conditions in Rule 2a-7 (the "Rule") promulgated by the SEC under the Investment Company Act of 1940. Under the Rule, the Trustees must establish procedures reasonably designed to stabilize the net asset value per share, as computed for purposes of distribution and redemption, at $1.00 per share, taking into account current market conditions and the Fund's investment objective. MONITORING PROCEDURES The Trustees' procedures include monitoring the relationship between the amortized cost value per Share and the net asset value per Share based upon available indications of market value. The Trustees will decide what, if any, steps should be taken if there is a difference of more than .5 of 1% between the two values. The Trustees will take any steps they consider appropriate (such as redemption in kind or shortening the average portfolio maturity) to minimize any material dilution or other unfair results arising from differences between the two methods of determining net asset value. INVESTMENT RESTRICTIONS The Rule requires that the Fund limit its investments to instruments that, in the opinion of the Trustees, present minimal credit risks and have received the requisite rating from one or more nationally recognized statistical rating organizations. If the instruments are not rated, the Trustees must determine that they are of comparable quality. The Rule also requires the Fund to maintain a dollar-weighted average portfolio maturity (not more than 90 days) appropriate to the objective of maintaining a stable net asset value of $1.00 per share. In addition, no instruments with a remaining maturity of more than 397 days can be purchased by the Fund. Should the disposition of a portfolio security result in a dollar-weighted average portfolio maturity of more than 90 days, the Fund will invest its available cash to reduce the average maturity to 90 days or less as soon as possible. The Fund may attempt to increase yield by trading portfolio securities to take advantage of short-term market variations. This policy may, from time to time, result in high portfolio turnover. Under the amortized cost method of valuation, neither the amount of daily income nor the net asset value is affected by any unrealized appreciation or depreciation of the portfolio. In periods of declining interest rates, the indicated daily yield on Shares computed by dividing the annualized daily income on the Fund's portfolio by the net asset value computed as above may tend to be higher than a similar computation made by using a method of valuation based upon market prices and estimates. In periods of rising interest rates, the indicated daily yield on Shares computed the same way may tend to be lower than a similar computation made by using a method of calculation based upon market prices and estimates. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class' net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends received as cash or additional Shares. No portion of any income dividend paid by the Fund is eligible for the dividends received deduction or exclusion available to corporations and individuals. These dividends and any short-term capital gains are taxable as ordinary income. CAPITAL GAINS Capital gains experienced by the Fund could result in an increase in dividends. Capital losses could result in a decrease in dividends. If for some extraordinary reason the Fund realizes net long-term capital gains, it will distribute them at least once every 12 months. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the seven-day period ended December 31, 1994 was 5.29%. The Fund's yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 5.09%. The Fund's yield for Class B Investment Shares for the seven-day period ended December 31, 1994 was 4.29%. The Fund calculates its yield daily, for all classes of Shares, based upon the seven days ending on the day of the calculation, called the "base period." This yield is computed by: .determining the net change in the value of a hypothetical account with a balance of one Share at the beginning of the base period, with the net change excluding capital changes but including the value of any additional Shares purchased with dividends earned from the original one Share and all dividends declared on the original and any purchased Shares; .dividing the net change in the account's value by the value of the account at the beginning of the base period to determine the base period return; and .multiplying the base period return by (365/7). To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in any class of Shares, the performance will be reduced for those shareholders paying those fees. EFFECTIVE YIELD - -------------------------------------------------------------------------------- The Fund's effective yield for Y Shares for the seven-day period ended December 31, 1994 was 5.43%. The Fund's effective yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 5.22%. The Fund's effective yield for Class B Investment Shares for the seven-day period ended December 31, 1994 was 4.38%. The Fund's effective yield for all classes of Shares is computed by compounding the unannualized base period return by: .adding 1 to the base period return; .raising the sum to the 365/7th power; and .subtracting 1 from the result. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates on money market instruments; .changes in the Fund's or any class of Shares' expenses; and .the relative amount of Fund cash flow. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all income dividends and capital gains distributions, if any. From time to time, the Fund will quote its Lipper ranking in the "money market instruments" category in advertising and sales literature. .BANK RATE MONITOR NATIONAL INDEX, Miami Beach, Florida, is a financial reporting service which publishes weekly average rates of 50 leading bank and thrift institution money market deposit accounts. The rates published in the index are averages of the personal account rates offered on the Wednesday prior to the date of publication by ten of the largest banks and thrifts in each of the five largest Standard Metropolitan Statistical Areas. Account minimums range upward from $2,500 in each institution, and compounding methods vary. If more than one rate is offered, the lowest rate is used. Rates are subject to change at any time specified by the institution. .DONOGHUE'S MONEY FUND REPORT publishes annualized yields of hundreds of money market funds on a weekly basis and through its Money Market Insight publication reports monthly and 12-month-to-date investment results for the same money funds. Advertisements and other sales literature for all classes of Shares may refer to total return. These total returns represent the historic change in the value of an investment in any class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Money Market Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Money Market Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. G00850-25 (2/95) FIRST UNION TAX FREE MONEY MARKET PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares or Class A Investment Shares for First Union Tax Free Money Market Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [logo] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 When-Issued and Delayed Delivery Transactions 3 Investing in Illiquid Securities 3 Temporary Investments 3 Lending of Portfolio Securities 4 Investment Risks 4 Investment Limitations 4 FIRST UNION FUNDS MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 8 Trustees Compensation 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 9 - --------------------------------------------------------------- Adviser to the Fund 9 Advisory Fees 9 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - --------------------------------------------------------------- PURCHASING SHARES 10 - --------------------------------------------------------------- Distribution Plan (Class A Investment Shares) 10 Conversion to Federal Funds 11 DETERMINING NET ASSET VALUE 11 - --------------------------------------------------------------- Use of the Amortized Cost Method 11 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 12 - --------------------------------------------------------------- The Fund's Tax Status 12 YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 13 - --------------------------------------------------------------- Tax Equivalency Table 13 EFFECTIVE YIELD 14 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 14 - --------------------------------------------------------------- FINANCIAL STATEMENTS 14 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Tax Free Money Market Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in two classes: Y Shares and Class A Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is to provide current income exempt from federal income tax while preserving capital and maintaining liquidity. The investment objective cannot be changed without approval of shareholders. TYPES OF INVESTMENTS The Fund invests primarily in municipal securities maturing in 397 days or less. CHARACTERISTICS The municipal securities in which the Fund invests have the characteristics set forth in the respective prospectus. A municipal security will be determined by the Trust's Board of Trustees ("Trustees") to be of high quality if it is of comparable quality to municipal securities within the Fund's rating requirements. When determining whether a municipal security presents minimal credit risks, the investment adviser considers the creditworthiness of 1) the issuer of a municipal security, 2) the issuer of a demand feature if the Fund has the unconditional right to demand payment for the municipal securities, or 3) any guarantor of payment by either of those issuers. The Fund is not required to sell a municipal security if the security's rating is reduced below the required minimum subsequent to the Fund's purchase of the security. The investment adviser considers this event, however, in its determination of whether the Fund should continue to hold the security in its portfolio. If ratings made by Moody's Investors Service, Inc., Standard & Poor's Ratings Group or Fitch Investors Service, Inc. change because of changes in those organizations or in their rating systems, the Fund will try to use comparable ratings as standards in accordance with the investment policies described in the Fund's respective prospectus. TYPES OF ACCEPTABLE INVESTMENTS Examples of municipal securities are: tax-exempt project notes issued by the Department of Housing and Urban Development to provide financing for housing, redevelopment, and urban renewal; municipal notes and tax-exempt commercial paper; serial bonds sold with a series of maturity dates; tax anticipation notes sold to finance working capital needs of municipalities in anticipation of receiving taxes at a later date; bond anticipation notes sold in anticipation of the issuance of longer-term bonds in the future; revenue anticipation notes sold in expectation of receipt of federal income available under the Federal Revenue Sharing Program; construction loan notes insured by the Federal Housing Administration and financed by the Federal or Government National Mortgage Association; and pre-refunded municipal bonds refundable at a later date. PARTICIPATION INTERESTS The financial institutions from which the Fund purchases participation interests frequently provide or secure from another financial institution irrevocable letters of credit or guarantees and give the Fund the right to demand payment of the principal amounts of the participation interests plus accrued interest on short notice (usually within seven days). The municipal securities subject to the participation interests are not limited to maturities of one year or less, so long as the participation interests include the right to demand payment from the issuers of those interests. These financial institutions may charge certain fees in connection with their repurchase commitments, including a fee equal to the excess of the interest paid on the municipal securities over the negotiated yield at which the participation interests were purchased by the Fund. By purchasing participation interests having a seven day demand feature, the - -------------------------------------------------------------------------------- Fund is buying a security meeting the maturity and quality requirements of the Fund and also is receiving the tax-free benefits of the underlying securities. VARIABLE RATE MUNICIPAL SECURITIES Variable interest rates generally reduce changes in the market value of municipal securities from their original purchase prices. Accordingly, as interest rates decrease or increase, the potential for capital appreciation or depreciation is less for variable rate municipal securities than for fixed income obligations. Many municipal securities with variable interest rates purchased by the Fund are subject to repayment of principal (usually within seven days) on the Fund's demand. For purposes of determining the Fund's average maturity, the maturities of these variable rate demand municipal securities (including participation interests) are the longer of the periods remaining until the next readjustment of their interest rates or the periods remaining until their principal amounts can be recovered by exercising the right to demand payment. The terms of these variable rate demand instruments require payment of principal and accrued interest from the issuer of the municipal obligations, the issuer of the participation interests, or a guarantor of either issuer. MUNICIPAL LEASES The Fund may purchase municipal securities in the form of participation interests which represent undivided proportional interests in lease payments by a governmental or nonprofit entity. The lease payments and other rights under the lease provide for and secure the payments on the certificates. Lease obligations may be limited by municipal charter or the nature of the appropriation for the lease. In particular, lease obligations may be subject to periodic appropriation. If the entity does not appropriate funds for future lease payments, the entity cannot be compelled to make such payments. Furthermore, a lease may provide that the certificate trustee cannot accelerate lease obligations upon default. The trustee would only be able to enforce lease payments as they became due. In the event of a default or failure of appropriation, it is unlikely that the trustee would be able to obtain an acceptable substitute source of payment. The municipal leases are not limited to maturities of one year or less, so long as they include the right to demand payment, typically within seven days, from the issuers of the municipal leases. While some municipal leases without this demand feature may not be considered liquid by the Fund's adviser, the Fund's investment limitations provide that it will invest no more than 10% of its net assets in illiquid securities. Municipal leases may be rated or unrated, but unrated leases purchased by the Fund will have been determined by the Fund's investment adviser to be of comparable quality at the time of the purchase to rated instruments eligible for purchase by the Fund pursuant to guidelines adopted by the Trustees. Where necessary to ensure that a municipal lease is of "high quality," the Fund will require that the issuer's obligation to pay the principal portion of the lease be backed by an unconditional bank letter or line of credit, guarantee or commitment to lend. While there may be no active secondary market with respect to a particular municipal lease purchased by the Fund, the Fund may, upon the notice specified in the municipal lease, demand payment at any time or during specified periods not exceeding one year, depending upon the instrument involved. The absence of such an active secondary market, however, could make it difficult for the Fund to dispose of a municipal lease if the issuer defaulted on its payment obligation or during the periods that the Fund is not entitled to exercise its demand rights. The Fund could, for this or other reasons, suffer a loss to the extent of the default. The Fund invests in municipal leases only when the Fund's investment adviser deems the investment to involve minimal credit risk. All municipal leases will meet the quality standards for the Fund. The investment adviser has been instructed by the Trustees to monitor the pricing, quality, and liquidity of the municipal leases held by the Fund and the continuing creditworthiness of issuers of such municipal leases on the basis of published financial information and reports of the rating agencies and other analytical services. When determining whether municipal leases purchased by the Fund will be classified as a liquid or illiquid security, the Trustees have directed the adviser to consider certain factors such as: the frequency of trades and quotes for the security; the volatility of quotations and trade prices for the security; the number of dealers willing to purchase or sell the security and the number of potential purchasers; dealer undertakings to make a market in the security; the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers, and the mechanics of transfer); the rating of the security and the financial condition and prospects of the issuer of the security; whether the lease can be terminated by the lessee; the potential recovery, if any, - -------------------------------------------------------------------------------- from a sale of the leased property upon termination of the lease; the lessee's general credit strength (e.g., its debt, administrative, economic and financial characteristics and prospects); the likelihood that the lessee will discontinue appropriating funding for the lease property because the property is no longer deemed essential to its operations (e.g., the potential for an 'event of nonappropriation"); any credit enhancement or legal recourse provided upon an event of nonappropriation or other termination of the lease; and such other factors as may be relevant to the Fund's ability to dispose of the security. STANDBY COMMITMENTS The Fund enters into standby commitments only with those dealers that the Fund's investment adviser believes are creditworthy. If a dealer were to default under its standby commitment, the ability of the Fund to sell the security could be reduced. If a dealer defaults under its standby commitment, the liquidity of the security subject to the commitment may be negatively affected. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of the value of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, non-negotiable fixed time deposits with maturities over seven days, and certain restricted securities not determined by the Trustees to be liquid. The ability of the Trustees to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 ("Rule 144A"). Rule 144A is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. Rule 144A provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. Rule 144A was expected to further enhance the liquidity of the secondary market for securities eligible for resale under Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities (eligible for resale under Rule 144A) for determination by the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: the frequency of trades and quotes for the security; the number of dealers willing to purchase or sell the security and the number of other potential buyers; dealer undertakings to make a market in the security; and the nature of the security and the nature of the marketplace trades. TEMPORARY INVESTMENTS The Fund may also invest in high quality temporary investments from time to time for temporary defensive purposes. REPURCHASE AGREEMENTS Repurchase agreements are arrangements in which banks, broker/dealers, and other recognized financial institutions sell U.S. government securities or other securities to the Fund and agree at the time of sale to repurchase them at a mutually agreed upon time and price. The Fund or its custodian will take possession of the securities subject to repurchase agreements and these securities will be marked to market daily. To the extent that the original seller does not repurchase the securities from the Fund, the Fund could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Fund might be delayed pending court action. The Fund believes that under the regular procedures normally in effect for custody of the Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Fund will only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are deemed by the Fund's adviser to be creditworthy pursuant to guidelines established by the Trustees. - -------------------------------------------------------------------------------- From time to time, such as when suitable municipal securities are not available, the Fund may invest a portion of its assets in cash. Any portion of the Fund's assets maintained in cash will reduce the amount of assets in municipal securities and thereby reduce the Fund's yield. REVERSE REPURCHASE AGREEMENTS The Fund may also enter into reverse repurchase agreements. This transaction is similar to borrowing cash. In a reverse repurchase agreement the Fund transfers possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agrees that on a stipulated date in the future the Fund will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Fund to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Fund will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of the Fund, in a dollar amount sufficient to make payment for the obligations to be purchased, are segregated on the Fund's records at the trade date. These securities are marked to market daily and maintained until the transaction is settled. LENDING OF PORTFOLIO SECURITIES The collateral received when the Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities. Loans are subject to termination at the option of the Fund or the borrower. The Fund may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Fund does not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. INVESTMENT RISKS Yields on municipal securities depend on a variety of factors, including: the general conditions of the short-term municipal note market and of the municipal bond market; the size of the particular offering; the maturity of the obligations; and the rating of the issue. The ability of the Fund to achieve its investment objective also depends on the continuing ability of the issuers of municipal securities and participation interests, or the guarantors of either, to meet their obligations for the payment of interest and principal when due. Litigation or legislation could affect the validity of certain municipal securities or their tax-free interest. For example, litigation challenging the validity of systems of financing public education has been initiated or adjudicated in a number of states. The Fund will not investigate such legislation or litigation unless it deems it necessary to do so. To the extent that litigation or legislation has an adverse effect on the ratings ascribed to a particular municipal security, there is some protection to the Fund's shareholders from the Fund's policy of buying only high-rated securities. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open, it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly or through reverse repurchase agreements as a temporary measure for extraordinary or emergency purposes and then only in amounts not in excess of 5% of the value of its total assets or in an amount up to one-third of the value of its total assets, including the amount borrowed, in order to meet redemption requests - -------------------------------------------------------------------------------- without immediately selling portfolio instruments. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of the value of its total assets are outstanding. The Fund will not borrow money or engage in reverse repurchase agreements for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the pledge. RESTRICTED SECURITIES The Fund will not invest more than 10% of its net assets in securities subject to restrictions on resale under the federal securities laws. INVESTING IN COMMODITIES The Fund will not purchase or sell commodities or commodity contracts. INVESTING IN REAL ESTATE The Fund will not purchase or sell real estate, although it may invest in the securities of issuers whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. UNDERWRITING The Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. LENDING CASH OR SECURITIES The Fund will not lend any of its assets, except that it may purchase or hold money market instruments, including repurchase agreements and variable amount demand master notes, in accordance with its investment objective, policies and limitations and lend portfolio securities valued at not more than 15% of its total assets to broker/dealers. CONCENTRATION OF INVESTMENTS The Fund will not invest more than 25% of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities and industrial development bonds as long as they are not from the same facility or similar types of facilities. DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its total assets, the Fund will not purchase securities issued by any one issuer (other than cash, cash items or securities issued or guaranteed by the government of the United States or its agencies or instrumentalities and repurchase agreements collateralized by such securities) if as a result more than 5% of the value of its total assets would be invested in the securities of that issuer. Under this limitation each governmental subdivision, including states and the District of Columbia, territories, possessions of the United States, or their political subdivisions, agencies, authorities, instrumentalities, or similar entities, will be considered a separate issuer if its assets and revenues are separate from those of the governmental body creating it and the security is backed only by its own assets and revenues. Industrial development bonds, backed only by the assets and revenues of a nongovernmental user, are considered to be issued solely by that user. If in the case of an industrial development bond or governmental-issued security, a governmental or other entity guarantees the security, such guarantee would be considered a separate security issued by the guarantor as well as the other issuer, subject to limited exclusions allowed by the Investment Company Act of 1940. - -------------------------------------------------------------------------------- INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by the Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of the value of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice, non-negotiable fixed time deposits with maturities over seven days, and certain restricted securities not determined by the Trustees to be liquid. The above limitations cannot be changed without shareholder approval. The following investment limitation, however, may be changed by Trustees without shareholder approval. Shareholders will be notified before any material change in these policies becomes effective. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST The Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust or its investment adviser, owning individually more than 0.5 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Although the following limitations are not fundamental restrictions or policies requiring a shareholder vote, the Fund has also undertaken to comply with the following limitations to a state securities authority for as long as the state authority requires and shares of the Fund are registered for sale in that state. INVESTING IN MINERALS The Fund will not purchase interests in oil, gas, or other mineral exploration or development programs, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN NEW ISSUERS The Fund will not invest more than 5% of its total assets in industrial development bonds or other municipal securities where the principal and interest are the responsibility of companies (or guarantors, where applicable) with less than three years of continuous operations, including the operation of any predecessor. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund did not borrow money or invest in reverse repurchase agreements in excess of 5% of the value of its net assets in the last fiscal year and has no present intent to do so in the coming fiscal year. In addition, the Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. For purposes of its policies and limitations, the Fund considers certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items". FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank of Charlotte, North Carolina owned approximately 52,762,889 Shares (99.99%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union National Bank of Florida of Charlotte, North Carolina owned approximately 186,576,376 Shares (35.20%); First Union National Bank of North Carolina of Charlotte, North Carolina owned approximately 127,581,984 Shares (24.07%); First Union National Bank of Charlotte, North Carolina owned approximately 27,333,557 Shares (5.16%); and First Union National Bank of Virginia of Charlotte, North Carolina owned approximately 26,503,837 Shares (5.0%). - -------------------------------------------------------------------------------- TRUSTEES COMPENSATION
AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Petit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700
*Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned $1,580,216, $1,115,932 and $752,305, of which $803,519, $750,857 and $192,581, were voluntarily waived, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. - -------------------------------------------------------------------------------- If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp. ("FSC") or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $0, $0, and $0, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $380,693, $277,930 and $197,412, in administrative service costs, of which $0, $0 and $192,581, were waived, respectively. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value without a sales charge on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." DISTRIBUTION PLAN (CLASS A INVESTMENT SHARES) With respect to the Class A Investment Shares of the Fund, the Trust has adopted a distribution plan (the "Plan") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plan permits the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A Investment Shares. The Plan is designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client - -------------------------------------------------------------------------------- inquiries regarding Class A Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A Investment Shares. By adopting the Plan, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plan include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal year ended December 31, 1994, the Fund incurred $1,204,943, in distribution services fees on behalf of Class A Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plan for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. CONVERSION TO FEDERAL FUNDS It is the Fund's policy to be as fully invested as possible so that maximum interest may be earned. To this end, all payments from shareholders must be in federal funds or be converted into federal funds. First Union and the custodian act as the shareholder's agent in depositing checks and converting them to federal funds. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- The Fund attempts to stabilize the value of its Shares at $1.00. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. USE OF THE AMORTIZED COST METHOD The Trustees have decided that the best method for determining the value of portfolio instruments is amortized cost. Under this method, portfolio instruments are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Fund's use of the amortized cost method of valuing portfolio instruments depends on its compliance with certain conditions in Rule 2a-7 (the "Rule") promulgated by the SEC under the Investment Company Act of 1940. Under the Rule, the Trustees must establish procedures reasonably designed to stabilize the net asset value per share, as computed for purposes of distribution and redemption, at $1.00 per share, taking into account current market conditions and the Fund's investment objective. MONITORING PROCEDURES The Trustees' procedures include monitoring the relationship between the amortized cost value per Share and the net asset value per Share based upon available indications of market value. The Trustees will decide what, if any, steps should be taken if there is a difference of more than .5 of 1% between the two values. The Trustees will take any steps they consider appropriate (such as redemption in kind or shortening the average portfolio maturity) to minimize any material dilution or other unfair results arising from differences between the two methods of determining net asset value. INVESTMENT RESTRICTIONS The Rule requires that the Fund limit its investments to instruments that, in the opinion of the Trustees, present minimal credit risks and have received the requisite rating from one or more nationally recognized statistical rating organizations. If the instruments are not rated, the Trustees must determine that they are of comparable quality. The Rule also requires the Fund to maintain a dollar-weighted average portfolio maturity (not more than 90 days) appropriate to the objective of maintaining a stable net asset - -------------------------------------------------------------------------------- value of $1.00 per share. In addition, no instruments with a remaining maturity of more than 397 days can be purchased by the Fund. Should the disposition of a portfolio security result in a dollar-weighted average portfolio maturity of more than 90 days, the Fund will invest its available cash to reduce the average maturity to 90 days or less as soon as possible. The Fund may attempt to increase yield by trading portfolio securities to take advantage of short-term market variations. This policy may, from time to time, result in high portfolio turnover. Under the amortized cost method of valuation, neither the amount of daily income nor the net asset value is affected by any unrealized appreciation or depreciation of the portfolio. In periods of declining interest rates, the indicated daily yield on Shares computed by dividing the annualized daily income on the Fund's portfolio by the net asset value computed as above may tend to be higher than a similar computation made by using a method of valuation based upon market prices and estimates. In periods of rising interest rates, the indicated daily yield on Shares computed the same way may tend to be lower than a similar computation made by using a method of calculation based upon market prices and estimates. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class' net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. CAPITAL GAINS Because the Fund invests in short-term money market instruments primarily for income, it is not expected to realize long-term capital gains. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the seven-day period ended December 31, 1994 was 4.90%. The Fund's yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 4.60%. The Fund calculates its yield daily for both classes of Shares, based upon the seven days ending on the day of the calculation, called the "base period." This yield is computed by: .determining the net change in the value of a hypothetical account with a balance of one Share at the beginning of the base period, with the net change excluding capital changes but including the value of any additional Shares purchased with dividends earned from the original one Share and all dividends declared on the original and any purchased Shares; .dividing the net change in the account's value by the value of the account at the beginning of the base period to determine the base period return; and .multiplying the base period return by 365/7. To the extent that financial institutions and brokers/dealers charge fees in connection with services provided in conjunction with an investment in either class of Shares, the performance will be reduced for those shareholders paying those fees. TAX EQUIVALENT YIELD - -------------------------------------------------------------------------------- The Fund's tax equivalent yield for Y Shares for the seven-day period ended December 31, 1994 was 6.81%. The Fund's tax equivalent yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 6.39%. The Fund's tax equivalent yield for both classes of Shares is calculated similarly to the yield, but is adjusted to reflect the taxable yield that either class would have had to earn to equal its actual yield, assuming a 28% tax rate (the maximum effective federal rate for individuals) and assuming that income is 100% tax-exempt. TAX EQUIVALENCY TABLE Both classes of Shares may also use a tax equivalency table in advertising and sales literature. The interest earned by the municipal bonds in the portfolio generally remains free from federal regular income tax,* and is often free from state and local taxes as well. As the table below indicates, a "tax-free" investment is an attractive choice for investors, particularly in times of narrow spreads between tax-free and taxable yields.
TAXABLE YIELD EQUIVALENT FOR 1995 - -------------------------------------------------------------------------------------------------------------------- Federal Income Tax Bracket: 15.00% 28.00% 31.00% 36.00% - -------------------------------------------------------------------------------------------------------------------- Joint Return: $1-39,000 $39,001-94,250 $94,251-143,600 $143,601-256,500 Single Return: $1-23,350 $23,351-56,550 $56,551-117,950 $117,951-256,500 - -------------------------------------------------------------------------------------------------------------------- Tax-Exempt Yield Taxable Yield Equivalent - -------------------------------------------------------------------------------------------------------------------- 1.00 % 1.18 % 1.39 % 1.45 % 1.56 % 1.50 1.76 2.08 2.17 2.34 2.00 2.35 2.78 2.90 3.13 2.50 2.94 3.47 3.62 3.91 3.00 3.53 4.17 4.35 4.69 3.50 4.12 4.86 5.07 5.47 4.00 4.71 5.56 5.80 6.25 4.50 5.29 6.25 6.52 7.03 5.00 5.88 6.94 7.25 7.81 5.50 6.47 7.64 7.97 8.59 6.00 7.06 8.33 8.70 9.38 6.50 7.65 9.03 9.42 10.16 7.00 8.24 9.72 10.14 10.94 7.50 8.82 10.42 10.87 11.72 8.00 9.41 11.11 11.59 12.50
- --------- 39.60% - --------- Joint Ret Over $256,500 Single Re Over $256,500 - --------- Tax-Exemp - --------- 1.66 % 2.48 3.31 4.14 4.97 5.79 6.62 7.45 8.28 9.11 9.93 10.76 11.59 12.42 13.25 Note: The maximum marginal tax rate for each bracket was used in calculating the taxable yield equivalent. The chart above is for illustrative purposes only. It is not an indicator of past or future performance of either class of Shares. *Some portion of each class' income may be subject to the federal alternative minimum tax and state and local taxes. EFFECTIVE YIELD - -------------------------------------------------------------------------------- The Fund's effective yield for Y Shares for the seven-day period ended December 31, 1994 was 5.02%. The Fund's effective yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 4.71%. The Fund's effective yield for both classes of Shares is computed by compounding the unannualized base period return by: .adding 1 to the base period return; .raising the sum to the (365/7)th power; and .subtracting 1 from the result. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of both classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates on money market instruments; .changes in the Fund's or either class of Shares' expenses; and .the relative amount of Fund cash flow. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all income dividends and capital gains distributions, if any. From time to time, the Fund will quote its Lipper ranking in the "short-term municipal bond funds" category in advertising and sales literature. .DONOGHUE'S MONEY FUND REPORT publishes annualized yields of hundreds of money market funds on a weekly basis and through its Money Market Insight publication reports monthly and 12-month-to-date investment results for the same money funds. Advertisements and other sales literature for both classes of Shares may refer to total return. These total returns represent the historic change in the value of an investment in either class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Tax Free Money Market Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Money Market Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. G00850-16 (2/95) FIRST UNION TREASURY MONEY MARKET PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares or Class A Investment Shares for First Union Treasury Money Market Portfolio, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares' prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the Class A Investment Shares' prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- When-Issued and Delayed Delivery Transactions 1 Investment Limitations 1 FIRST UNION FUNDS MANAGEMENT 2 - --------------------------------------------------------------- Officers and Trustees 2 Fund Ownership 3 Trustees Compensation 4 Trustee Liability 4 INVESTMENT ADVISORY SERVICES 4 - --------------------------------------------------------------- Adviser to the Fund 4 Advisory Fees 4 BROKERAGE TRANSACTIONS 5 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 5 - --------------------------------------------------------------- PURCHASING SHARES 5 - --------------------------------------------------------------- Distribution Plan (Class A Investment Shares) 5 Conversion to Federal Funds 6 DETERMINING NET ASSET VALUE 6 - --------------------------------------------------------------- Use of the Amortized Cost Method 6 REDEEMING SHARES 7 - --------------------------------------------------------------- Redemption in Kind 7 TAX STATUS 7 - --------------------------------------------------------------- The Fund's Tax Status 7 Shareholders' Tax Status 8 YIELD 8 - --------------------------------------------------------------- EFFECTIVE YIELD 8 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 8 - --------------------------------------------------------------- FINANCIAL STATEMENTS 9 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUND - -------------------------------------------------------------------------------- First Union Treasury Money Market Portfolio (the "Fund") is a portfolio of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Fund are offered in two classes: Y Shares and Class A Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Fund. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The Fund's investment objective is stability of principal and current income consistent with stability of principal. The Fund pursues its objective by investing in a portfolio consisting exclusively of short-term U.S. Treasury obligations. The investment objective cannot be changed without approval of shareholders. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Fund sufficient to make payment for the securities to be purchased are segregated on the Fund's records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Fund does not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of its assets. INVESTMENT LIMITATIONS BUYING ON MARGIN The Fund will not purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. SELLING SHORT The Fund will not make short sales of securities or maintain a short position, unless at all times when a short position is open it owns an equal amount of such securities or of securities which, without payment of any further consideration, are convertible into or exchangeable for securities of the same issue as, and equal in amount to, the securities sold short. ISSUING SENIOR SECURITIES AND BORROWING MONEY The Fund will not issue senior securities, except that the Fund may borrow money directly as a temporary measure for extraordinary or emergency purposes and then only in amounts not in excess of 5% of the value of its total assets or in an amount up to one-third of the value of its total assets, including the amount borrowed, in order to meet redemption requests without immediately selling portfolio instruments. Any such borrowings need not be collateralized. The Fund will not purchase any securities while borrowings in excess of 5% of the total value of its total assets are outstanding. The Fund will not borrow money for investment leverage purposes. PLEDGING ASSETS The Fund will not mortgage, pledge, or hypothecate any assets except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the pledge. LENDING CASH OR SECURITIES The Fund will not lend any of its assets, except that it may purchase or hold U.S. Treasury obligations, including repurchase agreements. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trust's Board of Trustees ("Trustees") without shareholder approval. Shareholders will be notified before any material changes in these limitations becomes effective. INVESTING IN ILLIQUID SECURITIES The Fund will not invest more than 10% of the value of its net assets in illiquid securities, including repurchase agreements providing for settlement in more than seven days after notice. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Fund will purchase securities of investment companies only in open-market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and therefore any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value or net assets will not result in a violation of such restriction. The Fund does not expect to borrow money, pledge securities, invest in reverse repurchase agreements, or engage in when-issued and delayed delivery transactions in excess of 5% of the value of its net assets in the last fiscal year and has no present to do so in the coming fiscal year. In addition, the Fund does not expect to invest more than 5% of its net assets in the securities of other investment companies during the coming year. FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees are listed with their addresses, present positions with First Union Funds, and principal occupations. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary PhysicianCare 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Fund: First Union National Bank of Charlotte, North Carolina owned approximately 198,311,100 Shares (99.99%). As of February 7, 1995, the following shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Fund: First Union National Bank of Florida of Charlotte, North Carolina owned approximately 247,971,009 Shares (30.57%); First Union National Bank of North Carolina of Charlotte, North Carolina owned approximately 152,522,568 Shares (18.81%); First Union National Bank of Virginia of Charlotte, North Carolina owned approximately 84,010,245 Shares (10.36%); and First Union National Bank of Georgia of Charlotte, North Carolina owned approximately 65,281,280 Shares (8.05%). TRUSTEES COMPENSATION AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700 *Information is furnished for fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUND The Fund's investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Fund or any shareholder of the Fund for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Fund's investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Adviser earned $2,549,955, $1,977,645, and $1,723,873, of which $1,948,237, $1,712,975, and $1,492,021, were voluntarily waived, respectively. STATE EXPENSE LIMITATIONS The Adviser has undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If the Fund's normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, the Adviser will reimburse the Fund for its expenses over the limitation. If the Fund's monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of the investment advisory fee. This arrangement is not part of the advisory contract and may be amended or rescinded in the future. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Adviser looks for prompt execution of the order at a favorable price. In working with dealers, the Adviser will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp. ("FSC") or their affiliates. The Adviser makes decisions on portfolio transactions and selects brokers and dealers subject to review by the Trustees. The Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Fund or to the Adviser and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Adviser and its affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Adviser in advising the Fund and other accounts. To the extent that receipt of these services may supplant services for which the Adviser or its affiliates might otherwise have paid, it would tend to reduce their expenses. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund paid $0, $0, and $0, respectively, in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for a fee as described in the respective prospectus. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $613,889, $490,126, and $453,609, in administrative service costs, of which $111,107, $198,476, and $208,794, were waived, respectively. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value without a sales charge on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." DISTRIBUTION PLAN (CLASS A INVESTMENT SHARES) With respect to the Class A Investment Shares class of the Fund, the Trust has adopted a distribution plan (the "Plan") pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission ("SEC") pursuant to the Investment Company Act of 1940. The Plan permits the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A Investment Shares. The Plan is designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and holders of Class A Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of Class A Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its Class A Investment Shares. By adopting the Plan, the Trustees expect that the Fund will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Fund in seeking to achieve its investment objectives. By identifying potential investors whose needs are served by the Fund's objectives, and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plan include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Fund, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the fiscal years ended December 31, 1994, 1993, and 1992, the Fund incurred $1,451,396, $756,661, and $632,023, respectively, in distribution services fees on behalf of Class A Investment Shares. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plan for administrative services, and if paid, will be reimbursed by the Adviser and not the Fund. CONVERSION TO FEDERAL FUNDS It is the Fund's policy to be as fully invested as possible so that maximum interest may be earned. To this end, all payments from shareholders must be in federal funds or be converted into federal funds. First Union and the custodian act as the shareholder's agent in depositing checks and converting them to federal funds. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- The Fund attempts to stabilize the value of its Shares at $1.00. The days on which the net asset values of Shares are calculated by the Fund are described in the respective prospectus. USE OF THE AMORTIZED COST METHOD The Trustees have decided that the best method for determining the value of portfolio instruments is amortized cost. Under this method, portfolio instruments are valued at the acquisition cost as adjusted for amortization of premium or accumulation of discount rather than at current market value. The Fund's use of the amortized cost method of valuing portfolio instruments depends on its compliance with certain conditions in Rule 2a-7 (the "Rule") promulgated by the SEC under the Investment Company Act of 1940. Under the Rule, the Trustees must establish procedures reasonably designed to stabilize the net asset value per share, as computed for purposes of distribution and redemption, at $1.00 per share, taking into account current market conditions and the Fund's investment objective. MONITORING PROCEDURES The Trustees' procedures include monitoring the relationship between the amortized cost value per Share and the net asset value per Share based upon available indications of market value. The Trustees will decide what, if any, steps should be taken if there is a difference of more than .5 of 1% between the two values. The Trustees will take any steps they consider appropriate (such as redemption in kind or shortening the average portfolio maturity) to minimize any material dilution or other unfair results arising from differences between the two methods of determining net asset value. INVESTMENT RESTRICTIONS The Rule requires that the Fund limit its investments to instruments that, in the opinion of the Trustees, present minimal credit risks and have received the requisite rating from one or more nationally recognized statistical rating organizations. If the instruments are not rated, the Trustees must determine that they are of comparable quality. The Rule also requires the Fund to maintain a dollar-weighted average portfolio maturity (not more than 90 days) appropriate to the objective of maintaining a stable net asset value of $1.00 per share. In addition, no instruments with a remaining maturity of more than 397 days can be purchased by the Fund. Should the disposition of a portfolio security result in a dollar-weighted average portfolio maturity of more than 90 days, the Fund will invest its available cash to reduce the average maturity to 90 days or less as soon as possible. The Fund may attempt to increase yield by trading portfolio securities to take advantage of short-term market variations. This policy may, from time to time, result in high portfolio turnover. Under the amortized cost method of valuation, neither the amount of daily income nor the net asset value is affected by any unrealized appreciation or depreciation of the portfolio. In periods of declining interest rates, the indicated daily yield on Shares computed by dividing the annualized daily income on the Fund's portfolio by the net asset value computed as above may tend to be higher than a similar computation made by using a method of valuation based upon market prices and estimates. In periods of rising interest rates, the indicated daily yield on Shares computed the same way may tend to be lower than a similar computation made by using a method of calculation based upon market prices and estimates. REDEEMING SHARES - -------------------------------------------------------------------------------- The Fund redeems Shares at the next computed net asset value after the Fund receives the redemption request. Redemptions will be made on days on which the Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the respective prospectus under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which the Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class' net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, the Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUND'S TAX STATUS The Fund will pay no federal income tax because it expects to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Fund must, among other requirements: .derive at least 90% of its gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of its gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to its shareholders at least 90% of its net income earned during the year. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends received as cash or additional Shares. No portion of any income dividend paid by the Fund is eligible for the dividends received deduction available to corporations. These dividends and any short-term capital gains are taxable as ordinary income. CAPITAL GAINS Capital gains experienced by the Fund could result in an increase in dividends. Capital losses could result in a decrease in dividends. If for some extraordinary reason the Fund realizes net long-term capital gains, it will distribute them at least once every 12 months. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Y Shares for the seven-day period ended December 31, 1994 was 5.27%. The Fund's yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 4.97%. The Fund calculates its yield daily for both classes of Shares, based upon the seven days ending on the day of the calculation, called the "base period." This yield is computed by: .determining the net change in the value of a hypothetical account with a balance of one Share at the beginning of the base period, with the net change excluding capital changes but including the value of any additional Shares purchased with dividends earned from the original one Share and all dividends declared on the original and any purchased Shares; .dividing the net change in the account's value by the value of the account at the beginning of the base period to determine the base period return; and .multiplying the base period return by 365/7. To the extent that financial institutions and broker/dealers charge fees in connection with services provided in conjunction with an investment in either class of Shares, the performance will be reduced for those shareholders paying those fees. EFFECTIVE YIELD - -------------------------------------------------------------------------------- The Fund's effective yield for Y Shares for the seven-day period ended December 31, 1994 was 5.41%. The Fund's effective yield for Class A Investment Shares for the seven-day period ended December 31, 1994 was 5.09%. The Fund's effective yield for both classes of Shares is computed by compounding the unannualized base period return by: .adding 1 to the base period return; .raising the sum to the (365/7)th power; and .subtracting 1 from the result. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of both classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates on money market instruments; .changes in the Fund's or either class of Shares' expenses; and .the relative amount of Fund cash flow. Investors may use financial publications and/or indices to obtain a more complete view of the Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Fund uses in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all income dividends and capital gains distributions, if any. From time to time, the Fund will quote its Lipper ranking in the "short-term U.S. government funds" category in advertising and sales literature. .BANK RATE MONITOR NATIONAL INDEX, Miami Beach, Florida, is a financial reporting service which publishes weekly average rates of 50 leading bank and thrift institution money market deposit accounts. The rates published in the index are averages of the personal account rates offered on the Wednesday prior to the date of publication by ten of the largest banks and thrifts in each of the five largest Standard Metropolitan Statistical Areas. Account minimums range upward from $2,500 in each institution, and compounding methods vary. If more than one rate is offered, the lowest rate is used. Rates are subject to change at any time specified by the institution. .DONOGHUE'S MONEY FUND REPORT publishes annualized yields of hundreds of money market funds on a weekly basis and through its Money Market Insight publication reports monthly and 12-month-to-date investment results for the same money funds. Advertisements and other sales literature for both classes of Shares may refer to total return. These total returns represent the historic change in the value of an investment in either class of Shares based on the monthly reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for the Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Treasury Money Market Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Money Market Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. G00850-14 (2/95) 1 PROSPECTUS FIRST UNION GROWTH FUNDS Y SHARES FEBRUARY 28, 1995 FIRST UNION GROWTH FUNDS Portfolios of First Union Funds Y SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes two diversified Growth Funds, three diversified Growth and Income Funds, three diversified Income Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Y Shares of First Union Growth Funds. It concisely describes the information which you should know before investing in Y Shares of either of the First Union Growth Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Growth Fund in the Combined Statement of Additional Information, dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statement is available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-2584. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - -------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS Summary 2 How to Convert Your Investment from - -------------------------------------- One First Union Fund to Another First Union Fund 17 Summary of Fund Expenses 4 -------------------------------------- - -------------------------------------- Financial Highlights 5 How to Redeem Shares 18 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 7 Management of First Union Funds 19 - -------------------------------------- -------------------------------------- Fees and Expenses 21 First Union Emerging Markets Growth -------------------------------------- Portfolio 7 - -------------------------------------- Shareholder Rights and Privileges 23 -------------------------------------- First Union International Equity Distributions and Taxes 25 Portfolio 8 -------------------------------------- - -------------------------------------- Types of Investments 8 Tax Information 25 - -------------------------------------- -------------------------------------- Other Investment Policies 9 Other Classes of Shares 26 - -------------------------------------- -------------------------------------- Shareholder Guide 15 Shareholder Report__________________27 - -------------------------------------- -------------------------------------- Addresses 28 How to Buy Shares 16 -------------------------------------- - -------------------------------------- SUMMARY DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Growth Fund is divided into four classes of shares: Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares") and Y Shares. Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). Class A, Class B, and Class C Shares are sold to individuals and other customers of First Union (the "Adviser") or its affiliates. This prospectus relates only to Y Shares ("Shares") of First Union Growth Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Y Shares are offered in the following two Funds: . First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund")--seeks to provide long-term capital appreciation. The Emerging Markets Growth Fund invests in equity securities of issuers located in countries with emerging markets; and . First Union International Equity Portfolio ("International Equity Fund")-- seeks to provide long-term capital appreciation. The International Equity Fund invests in equity securities of non-U.S. issuers. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. The Emerging Markets Growth Fund and the International Equity Fund are sub-advised by Marvin & Palmer Associates, Inc. ("Marvin & Palmer") and Boston International Advisors, Inc. ("Boston International"), respectively. PURCHASING AND REDEEMING SHARES For information on purchasing Y Shares of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The foreign securities in which the Funds may invest may be subject to certain risks in addition to those inherent in U.S. investments. The Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, investing in when-issued securities, lending portfolio securities and entering into futures contracts and related options as hedges. These risks are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS Y SHARES
Emerging Markets International Growth Fund Equity Fund ---------------- ------------- Y Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)............ None None Maximum Sales Load Imposed on Reinvested Divi- dends (as a percentage of offering price)............ None None Contingent Deferred Sales Charge (as a percent- age of original purchase price or redemption proceeds, as applicable)............ None None Redemption Fee (as a percentage of amount redeemed, if applicable)....................... None None Exchange Fee.................................... None None Annual Y Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (1)............... 0.00% 0.21% 12b-1 Fees...................................... None None Total Other Expenses (after waiver) (2)......... 1.50% 0.79% Total Y Shares Operating Expenses (3)......... 1.50% 1.00%
(1) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the anticipated voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (2) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.73% and 0.96%, respectively, absent the anticipated voluntary waiver by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these voluntary waivers and reimbursement at any time at their sole discretion. (3) The Total Y Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 1.53% and 1.06%, respectively, for the fiscal year ended December 31, 1994. Total Y Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 3.71% and 1.89%, respectively, for the fiscal year ended December 31, 1994. The Annual Y Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Y Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 4.23% and 1.78%, respectively, absent the voluntary waivers and reimbursements described above in notes 1 and 2. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, as- suming(1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Y Shares. Emerging Markets Growth Fund.................................. $15 $47 International Equity Fund..................................... $10 $32
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. This example is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Y Shares of the Funds. The Funds also offer three additional classes of shares called Class A Shares, Class B Shares, and Class C Shares. In general, all expenses are allocated based upon daily net assets of each class. Class A Shares, Class B Shares, and Class C Shares are subject to certain of the same expenses as Y Shares. However, Class A Shares are subject to a 12b-1 fee of 0.25 of 1%, and Class B Shares and Class C Shares are subject to a 12b-1 fee of 0.75 of 1% and a shareholder service fee of 0.25 of 1%. In addition, Class A Shares bear a maximum front-end sales load of 4.75%, Class B Shares bear a maximum contingent deferred sales charge of 5.00% and Class C Shares bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares." FINANCIAL HIGHLIGHTS First Union Emerging Markets Growth Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Y Investment Investment Investment Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.01 0.00 (0.02) (0.02) - ------------------------ Net realized and unrealized gain (loss) on investments and trans- lation of assets and liabilities in foreign currency (1.84) (1.83) (1.82) (1.82) - ------------------------ ------ ------ ------ ------ Total from investment operations (1.83) (1.83) (1.84) (1.84) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.00) (0.00) (0.00) (0.00) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 8.17 $ 8.17 $ 8.16 $ 8.16 - ------------------------ ------ ------ ------ ------ Total return+ (18.30%) (18.30%) (18.40%) (18.40%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.53%(b) 1.78%(b) 2.53%(b) 2.53%(b) - ------------------------ Net investment income 0.43%(b) (0.12%)(b) (0.84%)(b) (0.82%)(b) - ------------------------ Expense waiver/reimbursement (a) 2.18%(b) 2.18%(b) 2.18%(b) 2.18%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $5,878 $867 $1,589 $89 - ------------------------ Portfolio turnover rate 17% 17% 17% 17% - ------------------------
* Reflects operations for the period from September 6, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS First Union International Equity Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Y Investment Investment Investment Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.02 0.02 0.00 0.03 - ------------------------ Net realized and unrealized gain (loss) on investments (0.51) (0.52) (0.50) (0.54) - ------------------------ ------ ------ ------ ---------- Total from investment operations (0.49) (0.50) (0.50) (0.51) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.01) (0.00) (0.00) (0.00) - ------------------------ ------ ------ ------ ---------- Net asset value, end of period $ 9.50 $ 9.50 $ 9.50 $ 9.49 - ------------------------ ------ ------ ------ ---------- Total return+ (5.02%) (5.08%) (5.19%) (5.19%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.06%(b) 1.26%(b) 2.02%(b) 2.01%(b) - ------------------------ Net investment income 1.03%(b) 0.91%(b) 0.10%(b) 0.85%(b) - ------------------------ Expense waiver/reimbursement (a) 0.83%(b) 0.83%(b) 0.83%(b) 0.83%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $23,830 $2,545 $5,602 $163 - ------------------------ Portfolio turnover rate 1% 1% 1% 1% - ------------------------
* Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES AND POLICIES First Union Growth Funds offer investors the opportunity to invest in international equity securities of developed and emerging market issuers. The investment objectives and policies of both Funds are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION EMERGING MARKETS GROWTH PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of emerging market issuers. Suitable for: Aggressive investors interested in the investment opportunities offered by securities in emerging markets. Key Benefit: Provides potential for growth opportunities by investing in emerging markets experiencing political change, economic deregulation and liberalized trade policies. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in a diversified portfolio of equity securities of issuers located in countries with emerging markets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in securities of emerging market issuers. A country will be considered to have an "emerging market" if it has relatively low gross national product per capita compared to the world's major economies and the potential for rapid economic growth. Countries with emerging markets include those that have an emerging stock market (as defined by the International Finance Corporation), those with low- to middle-income economies (according to the World Bank), and those listed in World Bank publications as "developing." The Fund will normally invest in at least six different countries, although it may invest all of its assets in a single country. At the present time, the Fund has no intention to invest all of its assets in a single country. The Fund focuses on equity securities, but may also invest in other types of instruments, including debt securities. Marvin & Palmer, the Sub- Adviser to the Fund, will make investment decisions regarding equity securities based on its analysis of returns, price momentum, business and industry considerations, and management quality. FIRST UNION INTERNATIONAL EQUITY PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of non-U.S. issuers. Suitable for: Investors who want to pursue their investment goals in markets outside the United States. Key Benefit: Provides potential for investment opportunities in countries outside the U.S. due to differing economic and political cycles. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in foreign equity securities that Boston International, the Sub-Adviser to the Fund, determines, through both fundamental and technical analysis, to be undervalued compared to other securities in their industries and countries. In most market conditions, the stocks comprising the Fund's assets will exhibit traditional value characteristics, such as higher than average dividend yields, lower than average price to book value, and will include stocks of companies with unrecognized or undervalued assets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in equity securities of issuers located in at least three countries outside of the United States. The Fund will emphasize value stocks, primarily of companies which are listed on one or more of thirty-two stock markets: twenty developed markets and twelve emerging markets. While the current intention of the Fund is to invest in 32 stock markets, the Fund may invest in more or less, depending upon market conditions as determined by the Sub-Adviser. The Fund will invest substantially in industrialized companies throughout the world that comprise the Morgan Stanley Capital International EAFE (Europe, Australia and the Far East) Index. In addition, the Fund intends to invest up to 10% of its assets in emerging country equity securities, as described above under "First Union Emerging Markets Growth Portfolio--Description of the Fund." TYPES OF INVESTMENTS The Funds primarily invest in: common and preferred stocks, convertible securities and warrants of foreign corporations. Common stocks represent an equity interest in a corporation. This ownership interest often gives the Funds the right to vote on measures affecting the company's organization and operations. Although common stocks have a history of long-term growth in value, their prices tend to fluctuate in the short-term, particularly those of smaller capitalization companies. Smaller capitalization companies may have limited product lines, markets, or financial resources. These conditions may make them more susceptible to setbacks and reversals. Therefore, their securities may have limited marketability and may be subject to more abrupt or erratic market movements than securities of larger companies; obligations of foreign governments and supranational organizations; corporate and foreign government fixed income securities denominated in currencies other than U.S. dollars, rated, at the time of purchase, Baa or higher by Moody's Investors Service, Inc. ("Moody's") or BBB or higher by Standard & Poor's Ratings Group ("S&P"), or which, if unrated, are considered to be of comparable quality by the Sub-Advisers. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. Although the Funds do not intend to invest significantly in debt securities, it should be noted that the prices of fixed income securities fluctuate inversely to the direction of interest rates; strategic investments, such as options and futures contracts on currency transactions, securities index futures contracts, and forward foreign currency exchange contracts. The Funds can use these techniques to increase or decrease their exposure to changing security prices, interest rates, currency exchange rates, or other factors that affect security values. (Although, of course, there can be no assurance that these strategic investments will be successful in protecting the value of the Funds' securities.); securities of closed-end investment companies; and repurchase agreements collateralized by eligible investments. OTHER INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Funds' risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Funds to sell the security in the open market in the case of a default. In such a case, the Funds may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Funds purchase securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause the Funds to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, the Funds may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. FOREIGN CURRENCY TRANSACTIONS The Funds will enter into foreign currency transactions to obtain the necessary currencies to settle securities transactions. Currency transactions may be conducted either on a spot or cash basis at prevailing rates or through forward foreign currency exchange contracts. The Funds may also enter into foreign currency transactions to protect Fund assets against adverse changes in foreign currency exchange rates or exchange control regulations. Such changes could unfavorably affect the value of Fund assets which are denominated in foreign currencies, such as foreign securities or funds deposited in foreign banks, as measured in U.S. dollars. Although foreign currency exchanges may be used by a Fund to protect against a decline in the value of one or more currencies, such efforts may also limit any potential gain that might result from a relative increase in the value of such currencies and might, in certain cases, result in losses to the Fund. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS A forward foreign currency exchange contract ("forward contract") is an obligation to purchase or sell an amount of a particular currency at a specific price and on a future date agreed upon by the parties. Generally, no commission charges or deposits are involved. At the time a Fund enters into a forward contract, Fund assets with a value equal to the Fund's obligation under the forward contract are segregated and are maintained until the contract has been settled. The Funds will not enter into a forward contract with a term of more than one year. The Funds will generally enter into a forward contract to provide the proper currency to settle a securities transaction at the time the transaction occurs ("trade date"). The period between trade date and settlement date will vary between 24 hours and 60 days, depending upon local custom. The Funds may also protect against the decline of a particular foreign currency by entering into a forward contract to sell an amount of that currency approximating the value of all or a portion of the Funds' assets denominated in that currency ("hedging"). The success of this type of short- term hedging strategy is highly uncertain due to the difficulties of predicting short-term currency market movements and of precisely matching forward contract amounts and the constantly changing value of the securities involved. Although the Sub-Advisers will consider the likelihood of changes in currency values when making investment decisions, each Sub-Adviser believes that it is important to be able to enter into forward contracts when it believes the interests of a Fund will be served. The Funds will not enter into forward contracts for hedging purposes in a particular currency in an amount in excess of the Funds' assets denominated in that currency, but as consistent with their other investment policies and as not otherwise limited in their ability to use this strategy. OPTIONS AND FUTURES The Funds may deal in options on foreign currencies, securities indices and portfolio securities, which options may be listed for trading on an international securities exchange. The Funds will use these options to manage interest rate and currency risks. The Funds also may write covered call options and secured put options to generate income or to lock in gains. Each Fund may write covered call options and secured put options on up to 25% of its net assets and may purchase put and call options provided that no more than 5% of the fair market value of its net assets may be invested in premiums on such options. A call option gives the purchaser the right to buy, and the writer the obligation to sell, the underlying asset at the exercise price during the option period. A put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying asset at the exercise price during the option period. The writer of a covered call owns assets that are acceptable for escrow and the writer of a secured put invests an amount not less than the exercise price in eligible assets to the extent that it is obligated as a writer. If a call written by a Fund is exercised, the Fund forgoes any possible profit from an increase in the market price of the underlying asset over the exercise price plus the premium received. In writing puts, there is a risk that a Fund may be required to take delivery of the underlying asset at a disadvantageous price. The Funds may enter into futures contracts involving foreign currency and securities indices, or options on currency, for bona fide hedging purposes. The Funds may also enter into such futures contracts or related options for purposes other than bona fide hedging if the aggregate amount of initial margin deposits on a Fund's futures and related options positions would not exceed 5% of the net liquidation value of the Fund's assets, provided further that in the case of an option that is in-the-money at the time of the purchase, the in-the-money amount may be excluded in calculating the 5% limitation. In addition, a Fund may not sell futures contracts if the value of such futures contracts exceeds the total market value of the Fund's portfolio securities. Futures contracts sold by a Fund are generally subject to segregation and coverage requirements established by either the Commodity Futures Trading Commission ("CFTC") or the Securities and Exchange Commission ("SEC"), with the result that, if a Fund does not hold the instrument underlying the futures contract or option, the Fund will be required to segregate, on an ongoing basis with its custodian, cash, U.S. government securities, or other liquid high grade debt obligations in an amount at least equal to the Fund's obligations with respect to such instruments. The Funds may enter into securities index futures contracts and purchase and write put and call options on securities index futures contracts that are traded on regulated exchanges, including non-U.S. exchanges, to the extent permitted by the CFTC. Securities index futures contracts are based on indices that reflect the market value of securities of the firms included in the indices. An index futures contract is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to the differences between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally written. The Funds may enter into securities index futures contracts to sell a securities index in anticipation of or during a market decline to attempt to offset the decrease in market value of securities in its portfolio that might otherwise result. When a Fund is not fully invested and anticipates a significant market advance, it may enter into futures contracts to purchase the index in order to gain rapid market exposure that may in part or entirely offset increases in the cost of securities that it intends to purchase. In many of these transactions, a Fund will purchase such securities upon termination of the futures position but, depending on market conditions, a futures position may be terminated without the corresponding purchases of common stock. A Fund may also invest in securities index futures contracts when its Sub-Adviser believes such investment is more efficient, liquid or cost-effective than investing directly in the securities underlying the index. The use of futures and related options involves special considerations and risks, including: (1) the ability of a Fund to utilize futures successfully will depend on its Sub-Adviser's ability to predict pertinent market movements; and (2) there might be an imperfect correlation (or conceivably no correlation) between the change in the market value of the securities held by a Fund and the prices of the futures relating to the securities purchased or sold by the Fund. The use of futures and related options may reduce risk of loss by wholly or partially offsetting the negative effect of unfavorable price movements, but these instruments can also reduce the opportunity for gain by offsetting the positive effect of favorable price movements in positions. No assurance can be given that a Sub-Adviser's judgment in this respect will be correct. It is not certain that a secondary market for positions in futures contracts or for options will exist at all times. Although each Sub-Adviser will consider liquidity before entering into these transactions, there is no assurance that a liquid secondary market on an exchange or otherwise will exist for any particular futures contract or option at any particular time. A Fund's ability to establish and close out futures and options positions depends on this secondary market. RISK CHARACTERISTICS OF FOREIGN SECURITIES Investing in non-U.S. securities carries substantial risks in addition to those associated with domestic investments. In an attempt to reduce some of these risks, the Funds diversify their investments broadly among foreign countries which may include both developed and developing countries. With respect to the International Equity Fund, at least three different countries will always be represented. The Funds may take advantage of the unusual opportunities for higher returns available from investing in developing countries. As discussed in detail below under "Emerging Markets," however, these investments carry considerably more volatility and risk because they generally are associated with less mature economies and less stable political systems. Foreign securities are denominated in foreign currencies. Therefore, the value in U.S. dollars of a Fund's assets and income may be affected by changes in exchange rates and regulations. Although the Funds value their assets daily in U.S. dollars, they will not convert their holdings of foreign currencies to U.S. dollars daily. When a Fund converts its holdings to another currency, it may incur conversion costs. Foreign exchange dealers realize a profit on the difference between the prices at which such dealers buy and sell currencies. To the extent that securities purchased by the Funds are denominated in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the Funds' net asset values; the value of interest earned; gains and losses realized on the sale of securities; and net investment income and capital gains, if any, to be distributed to shareholders by a Fund. If the value of a foreign currency rises against the U.S. dollar, the value of a Fund's assets denominated in that currency will increase; correspondingly, if the value of a foreign currency declines against the U.S. dollar, the value of a Fund's assets denominated in that currency will decrease. Other differences between investing in foreign and U.S. companies include: less publicly available information about foreign companies; the lack of uniform financial accounting standards applicable to foreign companies; less readily available market quotations on foreign companies; differences in government regulation and supervision of foreign stock exchanges, brokers, listed companies, and banks; differences in legal systems which may affect the ability to enforce contractual obligations or obtain court judgments; generally lower foreign stock market volume; the likelihood that foreign securities may be less liquid or more volatile; foreign brokerage commissions may be higher; unreliable mail service between countries; and political or financial changes which adversely affect investments in some countries. In the past, U.S. government policies have discouraged or restricted certain investments abroad by investors such as the Funds. Although the Funds are unaware of any current restrictions, investors are advised that these policies could be reinstituted. EMERGING MARKETS The economies of individual emerging countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, currency depreciation, capital reinvestment, resource self-sufficiency and balance of payments position. Further, the economies of developing countries generally are heavily dependent on international trade and, accordingly, have been, and may continue to be, adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, adversely affected by economic conditions in the countries with which they trade. Prior governmental approval for foreign investments may be required under certain circumstances in some emerging countries, and the extent of foreign investment in certain debt securities and domestic companies may be subject to limitation in other emerging countries. Foreign ownership limitations also may be imposed by the charters of individual companies in emerging countries to prevent, among other concerns, violation of foreign investment limitations. Repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some emerging countries. A Fund could be adversely affected by delays in, or a refusal to grant, any required governmental registration or approval for such repatriation. Any investment subject to such repatriation controls will be considered illiquid if it appears reasonably likely that this process will take more than seven days. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, governmental regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or the value of the Funds' investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside of the U.S. TEMPORARY INVESTMENTS The Funds may invest in U.S. and foreign short-term money market instruments (denominated in U.S. and/or foreign currencies), including interest-bearing call deposits with banks, government obligations, certificates of deposit, bankers' acceptances, commercial paper, short-term corporate debt securities, and repurchase agreements. These investments may be used to temporarily invest cash received from the sale of Fund shares, to establish and maintain reserves for temporary defensive purposes, or to take advantage of market opportunities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Funds may invest up to 10% of their total assets in the securities of closed-end investment companies, including regional or single-country funds. To the extent that the Funds invest in securities issued by other investment companies, the Funds will indirectly bear their proportionate share of any fees and expenses paid by such companies, in addition to the fees and expenses payable directly by the Funds. RESTRICTED AND ILLIQUID SECURITIES The Funds may not invest more than 5% of their total assets in securities which are subject to restrictions on resale under federal securities law, except for restricted securities which meet the criteria for liquidity as established by the Trustees. The Funds may invest up to 15% of their net assets in illiquid securities. Illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one third of the value of its total assets and pledge up to 15% of the value of those assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of its total assets, neither Fund may invest more than 5% of its total assets in the securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. Each Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. There is a risk that when lending portfolio securities, the securities may not be available to the Funds on a timely basis and the Funds may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. DOWNGRADES If any security purchased by either of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. SHAREHOLDER GUIDE SHARE PRICE CALCULATION In the case of no-load Funds, the net asset value, the market price and the offering price of Shares are all the same. Purchases, redemptions, and exchanges are made at net asset value. The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of Shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Y Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yield of Y Shares is calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Y Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Total return and yield will be calculated separately for Y Shares, Class A Shares, Class B Shares and Class C Shares of a Fund. Because Class A Shares are subject to 12b-1 fees, and Class B Shares and Class C Shares are subject to a 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the contingent deferred sales charge ("CDSC"), which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order. MINIMUM INVESTMENT You may invest as often as you want in the Funds. There are no sales charges imposed on Y Shares of the Funds. However, there is a $1,000 minimum initial investment requirement which may be waived incertain situations. For further information, please contact the Capital Management Group of First Union at1- 800-326-2584. Subsequent investments may be in any amounts. BY TELEPHONE You may purchase Y Shares by telephone from the Capital Management Group of First Union at 1-800-326-2584. (Texas residents should directly contact the Mutual Funds Group of First Union Brokerage Services, Inc. at 1-800-326-3241.) Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. Purchase orders must be received by 4:00 p.m. (Eastern time). Payment is required on the next business day. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call First Union at 1-800-326-2584 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another, which may produce a gain or loss for tax purposes. You may exchange Y Shares of one First Union Fund for Y Shares of any other First Union Fund by calling toll free 1-800-326-2584 or by writing to First Union. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and, shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less any fees. You may redeem Shares in person or by telephoning First Union at 1-800-326-2584 or by written request to First Union. There is no redemption fee charged. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. MANAGEMENT OF FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Sub-Advisers, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31 , 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. William R. Hackney, III, is Senior Vice President and Chief Investment Officer of the Capital Management Group of First Union National Bank of North Carolina, N.A. Prior to assuming his current position with First Union, Mr. Hackney served as Regional Research Director for E.F. Hutton & Company's Southeast Region. Mr. Hackney has managed the Funds since their inception in September 1994. SUB-ADVISERS Under the terms of the Sub-Advisory Agreements between First Union National Bank and the respective Sub-Advisers, the Sub-Advisers will be responsible for managing that portion or all of each Fund's portfolio as designated by the Adviser, selecting investments for purchase or sale, along with the countries in which each Fund will invest and the dealers in portfolio securities, in accordance with each Fund's investment objectives, policies and limitations as stated herein. EMERGING MARKETS GROWTH FUND Marvin & Palmer Associates, Inc. is Sub-Adviser for the Emerging Markets Growth Fund. Marvin & Palmer, a privately-held company, was founded in 1986 by David F. Marvin and Stanley Palmer. The stock of Marvin & Palmer is owned by Mr. Marvin, Mr. Palmer and seventeen other shareholders. Marvin & Palmer is engaged in the management of global, non-United States and emerging markets equity portfolios for institutional accounts. At June 30, 1994, Marvin & Palmer managed a total of $2.5 billion in investments for 34 institutional investors and 5 commingled funds and served as sub-adviser to another investment company with total assets of $33 million. David F. Marvin is Chairman of the Sub-Adviser and founded the firm, together with Mr. Palmer, in 1986. With respect to the Emerging Markets Growth Fund, Mr. Marvin is primarily responsible for Latin America and currency management, and has served as co-portfolio manager of the Fund since its inception in September 1994. Stanley Palmer is President of the Sub-Adviser and a co-founder of the firm. With respect to the Emerging Markets Growth Fund, Mr. Palmer is, along with Todd D. Marvin, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. Terry B. Mason is a Vice President of and Portfolio Manager for the Sub- Adviser. Before joining the Sub-Adviser in 1990, Mr. Mason was employed for 14 years by DuPont Corporation, the last five as an International Equity Analyst and an International Trader. With respect to the Emerging Markets Growth Fund, Mr. Mason is primarily responsible for Eastern Europe and Africa, and has served as co-portfolio manager of the Fund since its inception in September 1994. Jay F. Middleton is a Portfolio Manager for the Sub-Adviser and joined the firm in 1989. With respect to the Emerging Markets Growth Fund, Mr. Middleton is primarily responsible for Latin America and the Middle East, and has served as co-portfolio manager of the Fund since its inception in September 1994. Todd D. Marvin is a Portfolio Manager for the Sub-Adviser and joined the firm in 1991. Before joining the Sub-Adviser, Mr. Marvin was employed by Oppenheimer & Company as an analyst in its investment banking department from 1989 until 1991. With respect to the Emerging Markets Growth Fund, Mr. Marvin is, along with Mr. Palmer, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. INTERNATIONAL EQUITY FUND Boston International Advisors, Inc. is Sub-Adviser for the International Equity Fund. Boston International commenced operations in 1986 and specializes in the management of international equity portfolios. Boston International manages eighteen international portfolios, including five group trust funds throughout the world. Messrs. Lyle H. Davis, Norman H. Meltz and David A. Umstead, the principal executive officers of Boston International, each owns more than 25% of the outstanding voting securities of Boston International. As of June 30, 1994, Boston International managed a total of $2.7 billion in assets and served as sub-adviser to one other investment company with total assets of $148 million. Maureen Ghublikian has been a Managing Director of the Sub-Adviser since the firm's inception in 1986. Ms. Ghublikian has served as co-portfolio manager of the Fund since its inception in September 1994. David A. Umstead was a founder and has been a Managing Director of the Sub- Adviser since the firm's inception in 1986. Mr. Umstead has served as co- portfolio manager of the Fund since its inception in September 1994. FUND ADMINISTRATION Federated Securities Corp., Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, another subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY, SUB-ADVISORY, AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Adviser receives an annual investment advisory fee with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- 1.50% on the first $100 million 1.45% on the next $100 million 1.40% on the next $100 million 1.35% on assets in excess of $300 million
International Equity Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- .82% on the first $20 million .79% on the next $30 million .76% on the next $50 million .73% on assets in excess of $100 million
The fees paid by the Emerging Markets Growth Fund and the International Equity Fund are higher than the advisory fees paid by other mutual funds in general; however, the fees paid by the International Equity Fund are comparable to fees paid by many mutual funds with similar investment objectives and policies. For its services under its Sub-Advisory Contract with the Adviser, each Sub- Adviser receives a monthly fee calculated on an annual basis, payable by the Adviser, for its services and expenses incurred with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund--Marvin & Palmer
Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- 1.00% on the first $100 million .95% on the next $100 million .90% on the next $100 million .85% on assets in excess of $300 million International Equity Fund--Boston International Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- .32% on the first $20 million .29% on the next $30 million .26% on the next $50 million .23% on assets in excess of $100 million
The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below:
Maximum Average Aggregate Daily Administrative Fee Net Assets of the Trust ------------------ ----------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million
Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND Y SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering a Fund and Shares of the Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal, and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND PRIVILEGES VOTING RIGHTS Each share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 1,471,138 shares (53.26%) and 1,290,972 shares (46.74%), respectively, of International Equity Fund--Y Shares; and First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 655,750 shares (84.77%) of the Emerging Markets Growth Fund--Y Shares; and First Union Brokerage Services ("FUBS") for the exclusive benefit of George M. Kingsbury, Miami, Florida, and for the exclusive benefit of Julio Noltenius, Julio G. Noltenius, and Alicia Noltenius, El Salvador, acting in various capacities for numerous accounts was the owner of record of 3,510 shares (31.60%) and 5,347 shares (48.14%), respectively, of the Emerging Markets Growth Fund--Class C Investment Shares, and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required, by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus and the Statement of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid annually for both Funds. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex- dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or First Union in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX INFORMATION Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended (the "Code") applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. However, the Funds may invest in the stock of certain foreign corporations which would constitute a Passive Foreign Investment Company ("PFIC"). Federal income taxes may be imposed on a Fund upon disposition of PFIC investments. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Investment income received by the Funds from sources within foreign countries may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with many foreign countries that entitle the Funds to reduced tax rates or exemptions on this income. The effective rate of foreign tax cannot be predicted since the amount of Fund assets to be invested within various countries will vary. However, the Funds intend to operate so as to qualify for treaty-reduced tax rates, where applicable. Unless otherwise exempt, shareholders are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Distributions representing net long-term capital gains realized by a Fund, if any, will be taxable as long-term capital gains regardless of the length of time shareholders have held their Shares. If more than 50%of the value of a Fund's assets at the end of the tax year is represented by stock or securities of foreign corporations, the Fund intends to qualify for certain Code stipulations that would allow shareholders to claim a foreign tax credit or deduction on their U.S. income tax returns. The Code may limit a shareholder's ability to claim a foreign tax credit. Furthermore, shareholders who elect to deduct their portion of a Fund's foreign taxes rather than take the foreign tax credit must itemize deductions on their income tax returns. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES OF SHARES First Union Growth Funds offer four classes of shares: Y Shares for institutional investors, and Class A Shares, Class B Shares and Class C Shares for individuals and other customers of First Union. Class A Shares, Class B Shares and Class C Shares of First Union Growth Funds are sold to customers of First Union and others at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B Shares and Class C Shares). Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non-qualified employee benefit and savings plans which make shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount up to 0.50 of 1% of the net asset value of Class A Shares purchased. These payments are subject to reclaim in the event the Class A Shares are redeemed within 12 months after purchase. Class A Shares, Class B Shares and Class C Shares are distributed pursuant to Rule 12b- 1 Plans adopted by the Trust, whereby the distributor is paid a fee of 0.25 of 1% for Class A Shares and 0.75 of 1% for Class B Shares and Class C Shares of each Fund's average daily net asset value. In addition, Class B Shares and Class C Shares pay a shareholder services fee of 0.25 of 1% of the respective class's average daily net assets. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares, and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either contact the Capital Management Group of First Union at 1-800-326-2584, or write the Trust. ADDRESSES - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Sub-Adviser to Emerging Markets Growth Fund Marvin & Palmer Associates, Inc. 1201 North Market Street Suite 2300 Wilmington, Delaware 19801- 1165 - -------------------------------------------------------------------------------- Sub-Adviser to International Equity Fund Boston International Advisors, Inc. 75 State Street Boston, Massachusetts 02109 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] Federated Securities Corp., Distributor 535672 (10/pkg.) G00850-10 (2/95) PROSPECTUS FIRST UNION GROWTH FUNDS CLASS A, B, AND C INVESTMENT SHARES FEBRUARY 28, 1995 [LOGO] FIRST UNION GROWTH FUNDS Portfolios of First Union Funds CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1995 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes two diversified Growth Funds, three diversified Growth and Income Funds, three diversified Income Funds, three diversified Money Market Funds, and one diversified and five non-diversified Tax-Free Funds. They are: Growth Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Growth and Income Funds . First Union Balanced Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Income Funds . First Union Fixed Income Portfolio; . First Union Managed Bond Portfolio; and . First Union U.S. Government Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Tax-Free Funds . First Union Florida Municipal Bond Portfolio; . First Union Georgia Municipal Bond Portfolio; . First Union North Carolina Municipal Bond Portfolio; . First Union South Carolina Municipal Bond Portfolio; . First Union Virginia Municipal Bond Portfolio; and . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio). This prospectus provides you with information specific to the Class A Investment Shares ("Class A Shares"), Class B Investment Shares ("Class B Shares"), and Class C Investment Shares ("Class C Shares") (collectively referred to as "Investment Shares") of First Union Growth Funds. It concisely describes the information which you should know before investing in Class A Shares, Class B Shares or Class C Shares of either of the First Union Growth Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Growth Fund in the Combined Statement of Additional Information, dated February 28, 1995, filed with the Securities and Exchange Commission and incorporated by reference into this prospectus. The Statement is available free of charge by writing to First Union Funds, Federated Investors Tower, Pittsburgh, PA 15222-3779 or by calling 1-800-326-3241. The Trust is sponsored and distributed by third parties independent of First Union National Bank of North Carolina ("First Union"). The shares offered by this prospectus are not deposits or obligations of First Union, are not endorsed or guaranteed by First Union, and are not insured by the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any other government agency. Investment in these shares involves investment risks, including the possible loss of principal. - -------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. TABLE OF CONTENTS Summary 2 How to Redeem Shares 20 - -------------------------------------- -------------------------------------- Summary of Fund Expenses 4 Additional Shareholder Services 20 - -------------------------------------- -------------------------------------- Financial Highlights 7 Management of First Union Funds 21 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 9 Fees and Expenses 24 - -------------------------------------- -------------------------------------- First Union Emerging Markets Growth Shareholder Rights and Privileges 25 Portfolio 9 -------------------------------------- - -------------------------------------- Distributions and Taxes 27 First Union International Equity -------------------------------------- Portfolio 9 - -------------------------------------- Tax Information 27 -------------------------------------- Types of Investments 10 - -------------------------------------- Other Classes of Shares 27 -------------------------------------- Other Investment Policies 10 - -------------------------------------- Shareholder Reports 28 -------------------------------------- Shareholder Guide 15 - -------------------------------------- Addresses 29 -------------------------------------- How to Buy Shares 16 - -------------------------------------- How to Convert Your Investment from One First Union Fund to Another First Union Fund 19 - -------------------------------------- SUMMARY DESCRIPTION OF THE TRUST First Union Funds is an open-end, management investment company, established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. The Trust currently consists of 17 portfolios, each representing a different First Union Fund. Each Growth Fund is divided into four classes of shares: Class A Shares, Class B Shares, Class C Shares and Y Shares. Class A, Class B, and Class C Shares are sold to individuals and other customers of First Union (the "Adviser") or its affiliates and are sold at net asset value plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (the Class A Shares), or (ii) on a contingent deferred basis (the Class B and Class C Shares). Y Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates to all three classes of Investment Shares ("Shares") of First Union Growth Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Class A, Class B, and Class C Shares are offered in the following two Funds: . First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund")--seeks to provide long-term capital appreciation. The Emerging Markets Growth Fund invests in equity securities of issuers located in countries with emerging markets; and . First Union International Equity Portfolio ("International Equity Fund")-- seeks to provide long-term capital appreciation. The International Equity Fund invests in equity securities of non-U.S. issuers. INVESTMENT MANAGEMENT The Funds are advised by First Union, through its Capital Management Group. First Union has responsibility for investment research and supervision of the Funds, in addition to the purchase or sale of portfolio instruments, for which it receives an annual fee. The Emerging Markets Growth Fund and the International Equity Fund are sub-advised by Marvin & Palmer Associates, Inc. ("Marvin & Palmer") and Boston International Advisors, Inc. ("Boston International"), respectively. PURCHASING AND REDEEMING SHARES For information on purchasing Class A, Class B, and Class C Shares of the Funds, please refer to the Shareholder Guide section entitled "How to Buy Shares." Redemption information may be found under "How to Redeem Shares." RISK FACTORS Investors should be aware of the following general observations. The foreign securities in which the Funds may invest may be subject to certain risks in addition to those inherent in U.S. investments. The Funds may make certain investments and employ certain investment techniques that involve other risks, including entering into repurchase agreements, investing in when-issued securities, lending portfolio securities and entering into futures contracts and related options as hedges. These risks are described under "Investment Objectives and Policies" for each Fund and "Other Investment Policies." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS A SHARES
Emerging Markets International Growth Fund Equity Fund ---------------- ------------- Class A Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)............ 4.75% 4.75% Maximum Sales Load Imposed on Reinvested Divi- dends (as a percentage of offering price)............ None None Contingent Deferred Sales Charge (as a percent- age of original purchase price or redemption proceeds, as applicable)............ None None Redemption Fees (as a percentage of amount re- deemed, if applicable)......................... None None Exchange Fee.................................... None None Annual Class A Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (1)............... 0.00% 0.21% 12b-1 Fees (2).................................. 0.25% 0.25% Total Other Expenses (after waiver) (3)......... 1.50% 0.79% Total Class A Shares Operating Expenses (4)... 1.75% 1.25%
(1) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the anticipated voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (2) The Class A Shares can pay up to 0.75 of 1% of Class A Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit the Class A Shares' 12b-1 payments to 0.25 of 1% of Class A Shares' average daily net assets. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.73% and 0.96%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class A Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 1.78% and 1.26%, respectively, for the fiscal year ended December 31, 1994. Total Class A Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 3.96% and 2.09%, respectively, for the fiscal year ended December 31, 1994. The Annual Class A Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class A Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 4.48% and 2.03%, respectively, absent the voluntary waivers and reimbursements described above in notes 1 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return; (2) redemption at the end of each time period; and (3) payment of maximum sales load. The Funds charge no redemption fees for Class A Shares. Emerging Markets Growth Fund................................. $64 $100 International Equity Fund.................................... $60 $ 85
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. This example is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class A Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 5.00%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. Y Shares, Class B Shares and Class C Shares do not bear a front-end sales load. See "Other Classes of Shares." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS B SHARES
Emerging Markets Growth Fund International Equity Fund ----------------------------- ----------------------------- Class B Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a percentage of original 5% during the first year, 5% during the first year, purchase price or 4% during the second year, 4% during the second year, redemption proceeds, as 3% during the third year, 3% during the third year, applicable) (1)........ 3% during the fourth year, 3% during the fourth year, 2% during the fifth year, 2% during the fifth year, 1% during the sixth year, 1% during the sixth year, 1% during the seventh year, 1% during the seventh year, and 0% after the seventh year and 0% after the seventh year Redemption Fees (as a percentage of amount redeemed, if applica- ble)................... None None Exchange Fee............ None None Annual Class B Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)............ 0.00% 0.21% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver) (3)..... 1.75% 1.04% Shareholder Services Fee................. 0.25% 0.25% Total Class B Shares Op- erating Expenses (4)................. 2.50% 2.00%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than seven years prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per Share. (2) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the anticipated voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.98% and 1.21%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class B Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 2.53% and 2.02%, respectively, for the fiscal year ended December 31, 1994. Total Class B Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 4.71% and 2.85%, respectively, for the fiscal year ended December 31, 1994. The Annual Class B Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class B Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 5.23% and 2.78%, respectively, absent the voluntary waivers and reimbursements described above in notes 2 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period: Emerging Markets Growth Fund....................................................... $77 $110 International Equity Fund.......................................................... $72 $96 You would pay the following expenses on the same investment, assuming no redemptions: Emerging Markets Growth Fund....................................................... $25 $78 International Equity Fund.......................................................... $20 $63
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The example for Class B Shares is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class B Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class A Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1%and bear a maximum sales load of 4.75%. Class C Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1% and bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares." SUMMARY OF FUND EXPENSES FIRST UNION GROWTH FUNDS CLASS C SHARES
Emerging Markets Growth Fund International Equity Fund --------------------------- --------------------------- Class C Shares Shareholder Transaction Expenses Maximum Sales Load Im- posed on Purchases (as a percentage of of- fering price).......... None None Maximum Sales Load Im- posed on Reinvested Dividends (as a percentage of of- fering price).......... None None Contingent Deferred Sales Charge (as a per- centage of original purchase price or redemption proceeds, as applica- 1% during the first year, 1% during the first year, ble) (1)............... and 0% after the first year and 0% after the first year Redemption Fees (as a percentage of amount redeemed, if applica- ble)................... None None Exchange Fee............ None None Annual Class C Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)............ 0.00% 0.21% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver) (3)..... 1.75% 1.04% Shareholder Services Fee.................... 0.25% 0.25% Total Class C Shares Operating Expenses (4). 2.50% 2.00%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than one year prior to redemption, (b) Shares acquired through the reinvestment of dividends and distributions, and (c) the portion of redemption proceeds attributable to increases in the value of an account above the net cost of the investment due to increases in the net asset value per Share. (2) The management fees of Emerging Markets Growth and International Equity Funds have been reduced to reflect the voluntary waivers by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fees for Emerging Markets Growth and International Equity Funds are 1.50% and 0.82%, respectively. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be 2.98% and 1.21%, respectively, absent the anticipated voluntary waivers by the Administrator, and additionally for Emerging Markets Growth Fund, the reimbursement of certain other expenses by the Adviser. The Administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The Total Class C Shares Operating Expenses for Emerging Markets Growth and International Equity Funds were 2.53% and 2.01%, respectively, for the fiscal year ended December 31, 1994. Total Class C Shares Operating Expenses for Emerging Markets Growth and International Equity Funds, absent the voluntary waivers by the Adviser and Administrator, were 4.71% and 2.84%, respectively, for the fiscal year ended December 31, 1994. The Annual Class C Shares Operating Expenses in the table above are based on expenses expected during the fiscal year ending December 31, 1995. The Total Class C Shares Expected Operating Expenses for Emerging Markets Growth and International Equity Funds would be 5.23% and 2.78%, respectively, absent the voluntary waivers and reimbursements described above in notes 2 and 3. * Expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1995. During the course of this period, expenses may be more or less than the average amount shown. The purpose of this table is to assist an investor in understanding the various costs and expenses that a shareholder of the Funds will bear, either directly or indirectly. For more complete descriptions of the various costs and expenses, see "Fees and Expenses." Wire-transferred redemptions of less than $5,000 may be subject to additional fees. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales loads permitted under the rules of the National Association of Securities Dealers, Inc.
EXAMPLE 1 year 3 years - ------- ------ ------- You would pay the following expenses on a $1,000 investment, assuming (1) a 5% annual return and (2) redemption at the end of each time period: Emerging Markets Growth Fund................................. $36 $78 International Equity Fund.................................... $31 $63 You would pay the following expenses on the same investment, assuming no redemptions: Emerging Markets Growth Fund................................. $25 $78 International Equity Fund.................................... $20 $63
The above example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. This example for Class C Shares is based on estimated data for the fiscal year ending December 31, 1995. The information set forth in the foregoing table and example relates only to Class C Shares of the Funds. The Funds also offer three additional classes of shares, called Y Shares, Class A Shares, and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Y Shares bear no sales load, 12b-1 fee or shareholder service fee. Class A Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales load of 4.75%. Class B Shares are subject to a 12b-1 fee of 0.75 of 1%, a shareholder service fee of 0.25 of 1%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales load. See "Other Classes of Shares." FINANCIAL HIGHLIGHTS First Union Emerging Markets Growth Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Y Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.00 (0.02) (0.02) 0.01 - ------------------------ Net realized and unrealized gain (loss) on investments and translation of assets and liabilities in for- eign currency (1.83) (1.82) (1.82) (1.84) - ------------------------ ------ ------ ------ ------ Total from investment operations (1.83) (1.84) (1.84) (1.83) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.00) (0.00) (0.00) (0.00) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 8.17 $ 8.16 $ 8.16 $ 8.17 - ------------------------ ------ ------ ------ ------ Total return+ (18.30%) (18.40%) (18.40%) (18.30%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.78%(b) 2.53%(b) 2.53%(b) 1.53%(b) - ------------------------ Net investment income (0.12%)(b) (0.84%)(b) (0.82%)(b) 0.43%(b) - ------------------------ Expense waiver/reimbursement (a) 2.18%(b) 2.18%(b) 2.18%(b) 2.18%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $867 $1,589 $89 $5,878 - ------------------------ Portfolio turnover rate 17% 17% 17% 17% - ------------------------
* Reflects operations for the period from September 6, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. FINANCIAL HIGHLIGHTS First Union International Equity Portfolio (For a share outstanding throughout the period) The following table has been audited by KPMG Peat Marwick LLP, the Fund's independent auditors. Their report, dated February 13, 1995, on the Fund's Financial Statements for the year ended December 31, 1994, and on the following table for each of the periods presented, is included in the Growth Funds' Annual Report, which is incorporated herein by reference. This table should be read in conjunction with the Fund's Financial Statements and notes thereto, contained in the Growth Funds' Annual Report, which may be obtained from the Fund.
Class A Class B Class C Investment Investment Investment Y Shares Shares Shares Shares ------------ ------------ ------------ ------------ Period Ended Period Ended Period Ended Period Ended December 31, December 31, December 31, December 31, ------------ ------------ ------------ ------------ 1994* 1994* 1994* 1994* - ------------------------ ------------ ------------ ------------ ------------ Net asset value, begin- ning of period $10.00 $10.00 $10.00 $10.00 - ------------------------ Income from investment operations - ------------------------ Net investment income 0.02 0.00 0.03 0.02 - ------------------------ Net realized and unrealized gain (loss) on investments (0.52) (0.50) (0.54) (0.51) - ------------------------ ------ ------ ------ ------ Total from investment operations (0.50) (0.50) (0.51) (0.49) - ------------------------ Less distributions - ------------------------ Dividends to sharehold- ers from net investment income (0.00) (0.00) (0.00) (0.01) - ------------------------ ------ ------ ------ ------ Net asset value, end of period $ 9.50 $ 9.50 $ 9.49 $ 9.50 - ------------------------ ------ ------ ------ ------ Total return+ (5.08%) (5.19%) (5.19%) (5.02%) - ------------------------ Ratios to Average Net Assets - ------------------------ Expenses 1.26%(b) 2.02%(b) 2.01%(b) 1.06%(b) - ------------------------ Net investment income 0.91%(b) 0.10%(b) 0.85%(b) 1.03%(b) - ------------------------ Expense waiver/reimbursement (a) 0.83%(b) 0.83%(b) 0.83%(b) 0.83%(b) - ------------------------ Supplemental Data - ------------------------ Net assets, end of pe- riod (000 omitted) $2,545 $5,602 $163 $23,830 - ------------------------ Portfolio turnover rate 1% 1% 1% 1% - ------------------------
* Reflects operations for the period from September 2, 1994 (commencement of operations) to December 31, 1994. + Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. (b) Computed on an annualized basis. Further information about the Fund's performance is contained in the Growth Funds' Annual Report, for the fiscal year ended December 31, 1994, which can be obtained free of charge. INVESTMENT OBJECTIVES AND POLICIES First Union Growth Funds offer investors the opportunity to invest in international equity securities of developed and emerging market issuers. The investment objectives and policies of both Funds are stated below. Each Fund's investment objective cannot be changed without shareholder approval. While there is no assurance that each objective will be achieved, the Funds will endeavor to do so by following the investment policies detailed below. Unless otherwise indicated, the investment policies of a Fund may be changed by the Trust's Board of Trustees ("Trustees") without the approval of shareholders. Shareholders will be notified before any material change in these policies becomes effective. FIRST UNION EMERGING MARKETS GROWTH PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of emerging market issuers. Suitable for: Aggressive investors interested in the investment opportunities offered by securities in emerging markets. Key Benefit: Provides potential for growth opportunities by investing in emerging markets experiencing political change, economic deregulation and liberalized trade policies. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in a diversified portfolio of equity securities of issuers located in countries with emerging markets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in securities of emerging market issuers. A country will be considered to have an "emerging market" if it has relatively low gross national product per capita compared to the world's major economies and the potential for rapid economic growth. Countries with emerging markets include those that have an emerging stock market (as defined by the International Finance Corporation), those with low- to middle-income economies (according to the World Bank), and those listed in World Bank publications as "developing." The Fund will normally invest in at least six different countries, although it may invest all of its assets in a single country. At the present time, the Fund has no intention to invest all of its assets in a single country. The Fund focuses on equity securities, but may also invest in other types of instruments, including debt securities. Marvin & Palmer, the Sub- Adviser to the Fund, will make investment decisions regarding equity securities based on its analysis of returns, price momentum, business and industry considerations, and management quality. FIRST UNION INTERNATIONAL EQUITY PORTFOLIO Objective: Long-term capital appreciation. Invests in: Equity securities of non-U.S. issuers. Suitable for: Investors who want to pursue their investment goals in markets outside the United States. Key Benefit: Provides potential for investment opportunities in countries outside the U.S. due to differing economic and political cycles. DESCRIPTION OF THE FUND The Fund seeks long-term capital appreciation. The Fund invests primarily in foreign equity securities that Boston International, the Sub-Adviser to the Fund, determines, through both fundamental and technical analysis, to be undervalued compared to other securities in their industries and countries. In most market conditions, the stocks comprising the Fund's assets will exhibit traditional value characteristics, such as higher than average dividend yields, lower than average price to book value, and will include stocks of companies with unrecognized or undervalued assets. As a matter of policy, the Fund will invest at least 65% of the value of its total assets in equity securities of issuers located in at least three countries outside of the United States. The Fund will emphasize value stocks, primarily of companies which are listed on one or more of thirty-two stock markets: twenty developed markets and twelve emerging markets. While the current intention of the Fund is to invest in 32 stock markets, the Fund may invest in more or less, depending upon market conditions as determined by the Sub-Adviser. The Fund will invest substantially in industrialized companies throughout the world that comprise the Morgan Stanley Capital International EAFE (Europe, Australia and the Far East) Index. In addition, the Fund intends to invest up to 10% of its assets in emerging country equity securities, as described above under "First Union Emerging Markets Growth Portfolio--Description of the Fund." TYPES OF INVESTMENTS The Funds primarily invest in: common and preferred stocks, convertible securities and warrants of foreign corporations. Common stocks represent an equity interest in a corporation. This ownership interest often gives the Funds the right to vote on measures affecting the company's organization and operations. Although common stocks have a history of long-term growth in value, their prices tend to fluctuate in the short-term, particularly those of smaller capitalization companies. Smaller capitalization companies may have limited product lines, markets, or financial resources. These conditions may make them more susceptible to setbacks and reversals. Therefore, their securities may have limited marketability and may be subject to more abrupt or erratic market movements than securities of larger companies; obligations of foreign governments and supranational organizations; corporate and foreign government fixed income securities denominated in currencies other than U.S. dollars, rated, at the time of purchase, Baa or higher by Moody's Investors Service, Inc. ("Moody's") or BBB or higher by Standard & Poor's Ratings Group ("S&P"), or which, if unrated, are considered to be of comparable quality by the Sub-Advisers. Bonds rated Baa by Moody's or BBB by S&P have speculative characteristics. Changes in economic conditions or other circumstances are more likely to lead to weakened capacity to make principal and interest payments than higher rated bonds. Although the Funds do not intend to invest significantly in debt securities, it should be noted that the prices of fixed income securities fluctuate inversely to the direction of interest rates; strategic investments, such as options and futures contracts on currency transactions, securities index futures contracts, and forward foreign currency exchange contracts. The Funds can use these techniques to increase or decrease their exposure to changing security prices, interest rates, currency exchange rates, or other factors that affect security values. (Although, of course, there can be no assurance that these strategic investments will be successful in protecting the value of the Funds' securities.); securities of closed-end investment companies; and repurchase agreements collateralized by eligible investments. OTHER INVESTMENT POLICIES The Funds have adopted the following practices for specific types of investments. REPURCHASE AGREEMENTS The Funds may invest in repurchase agreements. Repurchase agreements are agreements by which a Fund purchases a security for cash and obtains a simultaneous commitment from the seller (usually a bank or broker/dealer) to repurchase the security at an agreed-upon price and specified future date. The repurchase price reflects an agreed-upon interest rate for the time period of the agreement. The Funds' risk is the inability of the seller to pay the agreed-upon price on the delivery date. However, this risk is tempered by the ability of the Funds to sell the security in the open market in the case of a default. In such a case, the Funds may incur costs in disposing of the security which would increase Fund expenses. The Adviser will monitor the creditworthiness of the firms with which the Funds enter into repurchase agreements. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Funds may purchase securities on a when-issued or delayed delivery basis. These transactions are arrangements in which the Funds purchase securities with payment and delivery scheduled for a future time. The seller's failure to complete these transactions may cause the Funds to miss a price or yield considered to be advantageous. Settlement dates may be a month or more after entering into these transactions, and the market values of the securities purchased may vary from the purchase prices. Accordingly, the Funds may pay more or less than the market value of the securities on the settlement date. The Funds may dispose of a commitment prior to settlement if the Adviser deems it appropriate to do so. In addition, the Funds may enter into transactions to sell their purchase commitments to third parties at current market values and simultaneously acquire other commitments to purchase similar securities at later dates. The Funds may realize short-term profits or losses upon the sale of such commitments. FOREIGN CURRENCY TRANSACTIONS The Funds will enter into foreign currency transactions to obtain the necessary currencies to settle securities transactions. Currency transactions may be conducted either on a spot or cash basis at prevailing rates or through forward foreign currency exchange contracts. The Funds may also enter into foreign currency transactions to protect Fund assets against adverse changes in foreign currency exchange rates or exchange control regulations. Such changes could unfavorably affect the value of Fund assets which are denominated in foreign currencies, such as foreign securities or funds deposited in foreign banks, as measured in U.S. dollars. Although foreign currency exchanges may be used by a Fund to protect against a decline in the value of one or more currencies, such efforts may also limit any potential gain that might result from a relative increase in the value of such currencies and might, in certain cases, result in losses to the Fund. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS A forward foreign currency exchange contract ("forward contract") is an obligation to purchase or sell an amount of a particular currency at a specific price and on a future date agreed upon by the parties. Generally, no commission charges or deposits are involved. At the time a Fund enters into a forward contract, Fund assets with a value equal to the Fund's obligation under the forward contract are segregated and are maintained until the contract has been settled. The Funds will not enter into a forward contract with a term of more than one year. The Funds will generally enter into a forward contract to provide the proper currency to settle a securities transaction at the time the transaction occurs ("trade date"). The period between trade date and settlement date will vary between 24 hours and 60 days, depending upon local custom. The Funds may also protect against the decline of a particular foreign currency by entering into a forward contract to sell an amount of that currency approximating the value of all or a portion of the Funds' assets denominated in that currency ("hedging"). The success of this type of short-term hedging strategy is highly uncertain due to the difficulties of predicting short-term currency market movements and of precisely matching forward contract amounts and the constantly changing value of the securities involved. Although the Sub- Advisers will consider the likelihood of changes in currency values when making investment decisions, each Sub-Adviser believes that it is important to be able to enter into forward contracts when it believes the interests of a Fund will be served. The Funds will not enter into forward contracts for hedging purposes in a particular currency in an amount in excess of the Funds' assets denominated in that currency, but as consistent with their other investment policies and as not otherwise limited in their ability to use this strategy. OPTIONS AND FUTURES The Funds may deal in options on foreign currencies, securities indices and portfolio securities, which options may be listed for trading on an international securities exchange. The Funds will use these options to manage interest rate and currency risks. The Funds also may write covered call options and secured put options to generate income or to lock in gains. Each Fund may write covered call options and secured put options on up to 25% of its net assets and may purchase put and call options provided that no more than 5% of the fair market value of its net assets may be invested in premiums on such options. A call option gives the purchaser the right to buy, and the writer the obligation to sell, the underlying asset at the exercise price during the option period. A put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying asset at the exercise price during the option period. The writer of a covered call owns assets that are acceptable for escrow and the writer of a secured put invests an amount not less than the exercise price in eligible assets to the extent that it is obligated as a writer. If a call written by a Fund is exercised, the Fund forgoes any possible profit from an increase in the market price of the underlying asset over the exercise price plus the premium received. In writing puts, there is a risk that a Fund may be required to take delivery of the underlying asset at a disadvantageous price. The Funds may enter into futures contracts involving foreign currency and securities indices, or options on currency, for bona fide hedging purposes. The Funds may also enter into such futures contracts or related options for purposes other than bona fide hedging if the aggregate amount of initial margin deposits on a Fund's futures and related options positions would not exceed 5% of the net liquidation value of the Fund's assets, provided further that in the case of an option that is in-the-money at the time of the purchase, the in-the-money amount may be excluded in calculating the 5% limitation. In addition, a Fund may not sell futures contracts if the value of such futures contracts exceeds the total market value of the Fund's portfolio securities. Futures contracts sold by a Fund are generally subject to segregation and coverage requirements established by either the Commodity Futures Trading Commission ("CFTC") or the Securities and Exchange Commission ("SEC"), with the result that, if a Fund does not hold the instrument underlying the futures contract or option, the Fund will be required to segregate, on an ongoing basis with its custodian, cash, U.S. government securities, or other liquid high grade debt obligations in an amount at least equal to the Fund's obligations with respect to such instruments. The Funds may enter into securities index futures contracts and purchase and write put and call options on securities index futures contracts that are traded on regulated exchanges, including non-U.S. exchanges, to the extent permitted by the CFTC. Securities index futures contracts are based on indices that reflect the market value of securities of the firms included in the indices. An index futures contract is an agreement pursuant to which two parties agree to take or make delivery of an amount of cash equal to the differences between the value of the index at the close of the last trading day of the contract and the price at which the index contract was originally written. The Funds may enter into securities index futures contracts to sell a securities index in anticipation of or during a market decline to attempt to offset the decrease in market value of securities in its portfolio that might otherwise result. When a Fund is not fully invested and anticipates a significant market advance, it may enter into futures contracts to purchase the index in order to gain rapid market exposure that may in part or entirely offset increases in the cost of securities that it intends to purchase. In many of these transactions, a Fund will purchase such securities upon termination of the futures position but, depending on market conditions, a futures position may be terminated without the corresponding purchases of common stock. A Fund may also invest in securities index futures contracts when its Sub-Adviser believes such investment is more efficient, liquid or cost-effective than investing directly in the securities underlying the index. The use of futures and related options involves special considerations and risks, including: (1) the ability of a Fund to utilize futures successfully will depend on its Sub-Adviser's ability to predict pertinent market movements; and (2) there might be an imperfect correlation (or conceivably no correlation) between the change in the market value of the securities held by a Fund and the prices of the futures relating to the securities purchased or sold by the Fund. The use of futures and related options may reduce risk of loss by wholly or partially offsetting the negative effect of unfavorable price movements, but these instruments can also reduce the opportunity for gain by offsetting the positive effect of favorable price movements in positions. No assurance can be given that a Sub-Adviser's judgment in this respect will be correct. It is not certain that a secondary market for positions in futures contracts or for options will exist at all times. Although each Sub-Adviser will consider liquidity before entering into these transactions, there is no assurance that a liquid secondary market on an exchange or otherwise will exist for any particular futures contract or option at any particular time. A Fund's ability to establish and close out futures and options positions depends on this secondary market. RISK CHARACTERISTICS OF FOREIGN SECURITIES Investing in non-U.S. securities carries substantial risks in addition to those associated with domestic investments. In an attempt to reduce some of these risks, the Funds diversify their investments broadly among foreign countries which may include both developed and developing countries. With respect to the International Equity Fund, at least three different countries will always be represented. The Funds may take advantage of the unusual opportunities for higher returns available from investing in developing countries. As discussed in detail below under "Emerging Markets," however, these investments carry considerably more volatility and risk because they generally are associated with less mature economies and less stable political systems. Foreign securities are denominated in foreign currencies. Therefore, the value in U.S. dollars of a Fund's assets and income may be affected by changes in exchange rates and regulations. Although the Funds value their assets daily in U.S. dollars, they will not convert their holdings of foreign currencies to U.S. dollars daily. When a Fund converts its holdings to another currency, it may incur conversion costs. Foreign exchange dealers realize a profit on the difference between the prices at which such dealers buy and sell currencies. To the extent that securities purchased by the Funds are denominated in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the Funds' net asset values; the value of interest earned; gains and losses realized on the sale of securities; and net investment income and capital gains, if any, to be distributed to shareholders by a Fund. If the value of a foreign currency rises against the U.S. dollar, the value of a Fund's assets denominated in that currency will increase; correspondingly, if the value of a foreign currency declines against the U.S. dollar, the value of a Fund's assets denominated in that currency will decrease. Other differences between investing in foreign and U.S. companies include: less publicly available information about foreign companies; the lack of uniform financial accounting standards applicable to foreign companies; less readily available market quotations on foreign companies; differences in government regulation and supervision of foreign stock exchanges, brokers, listed companies, and banks; differences in legal systems which may affect the ability to enforce contractual obligations or obtain court judgments; generally lower foreign stock market volume; the likelihood that foreign securities may be less liquid or more volatile; foreign brokerage commissions may be higher; unreliable mail service between countries; and political or financial changes which adversely affect investments in some countries. In the past, U.S. government policies have discouraged or restricted certain investments abroad by investors such as the Funds. Although the Funds are unaware of any current restrictions, investors are advised that these policies could be reinstituted. EMERGING MARKETS The economies of individual emerging countries may differ favorably or unfavorably from the U.S. economy in such respects as growth of gross domestic product, rate of inflation, currency depreciation, capital reinvestment, resource self-sufficiency and balance of payments position. Further, the economies of developing countries generally are heavily dependent on international trade and, accordingly, have been, and may continue to be, adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values and other protectionist measures imposed or negotiated by the countries with which they trade. These economies also have been, and may continue to be, adversely affected by economic conditions in the countries with which they trade. Prior governmental approval for foreign investments may be required under certain circumstances in some emerging countries, and the extent of foreign investment in certain debt securities and domestic companies may be subject to limitation in other emerging countries. Foreign ownership limitations also may be imposed by the charters of individual companies in emerging countries to prevent, among other concerns, violation of foreign investment limitations. Repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some emerging countries. A Fund could be adversely affected by delays in, or a refusal to grant, any required governmental registration or approval for such repatriation. Any investment subject to such repatriation controls will be considered illiquid if it appears reasonably likely that this process will take more than seven days. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, governmental regulation, social instability or diplomatic developments (including war) which could affect adversely the economics of such countries or the value of the Funds' investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside ofthe U.S. TEMPORARY INVESTMENTS The Funds may invest in U.S. and foreign short-term money market instruments (denominated in U.S. and/or foreign currencies), including interest-bearing call deposits with banks, government obligations, certificates of deposit, bankers' acceptances, commercial paper, short-term corporate debt securities, and repurchase agreements. These investments may be used to temporarily invest cash received from the sale of Fund shares, to establish and maintain reserves for temporary defensive purposes, or to take advantage of market opportunities. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES The Funds may invest up to 10% of their total assets in the securities of closed-end investment companies, including regional or single-country funds. To the extent that the Funds invest in securities issued by other investment companies, the Funds will indirectly bear their proportionate share of any fees and expenses paid by such companies, in addition to the fees and expenses payable directly by the Funds. RESTRICTED AND ILLIQUID SECURITIES The Funds may not invest more than 5% of their total assets in securities which are subject to restrictions on resale under federal securities law, except for restricted securities which meet the criteria for liquidity as established by the Trustees. The Funds may invest up to 15% of their net assets in illiquid securities. Illiquid securities include certain restricted securities not determined by the Trustees to be liquid, non-negotiable time deposits, and repurchase agreements providing for settlement in more than seven days after notice. The following investment limitations cannot be changed without shareholder approval. BORROWING MONEY The Funds will not borrow money directly or through reverse repurchase agreements or pledge securities, except under certain circumstances, a Fund may borrow up to one third of the value of its total assets and pledge up to 15% of the value of those assets to secure such borrowings. DIVERSIFICATION With respect to 75% of the value of its total assets, neither Fund may invest more than 5% of its total assets in the securities of one issuer (except cash or cash items, repurchase agreements collateralized by U.S. government securities and U.S. government obligations) or own more than 10% of the outstanding voting securities of one issuer. LENDING OF PORTFOLIO SECURITIES In order to generate additional income, the Funds may lend portfolio securities on a short-term or long-term basis to broker/dealers, banks, or other institutional borrowers of securities. The Funds will only enter into loan arrangements with creditworthy borrowers and will receive collateral in the form of cash or U.S. government securities equal to at least 100% of the value of the securities loaned. Each Fund will not lend any of its assets except portfolio securities up to one-third of the value of its total assets. There is the risk that when lending portfolio securities, the securities may not be available to the Funds on a timely basis and the Funds may, therefore, lose the opportunity to sell the securities at a desirable price. In addition, in the event that a borrower of securities would file for bankruptcy or become insolvent, disposition of the securities may be delayed pending court action. DOWNGRADES If any security purchased by either of the Funds loses its rating or has its rating reduced after the Fund has purchased it, the Fund is not required to sell or otherwise dispose of the security, but may consider doing so. SHAREHOLDER GUIDE CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing Class A Shares, Class B Shares or Class C Shares. Your decision will be based on the amount of your intended purchase and how long you expect to hold the Shares. Each Fund offers three types of Investment Shares: Class A Shares, Class B Shares and Class C Shares. Each Share of the Fund represents an identical interest in the investment portfolio of the Fund and has the same rights. The difference between Class A Shares, Class B Shares, and Class C Shares is based on purchasing arrangements and distribution and shareholder services expenses. Class A Shares have a sales charge included at the time of purchase and are subject to a Rule 12b-1 distribution fee of 0.25 of 1%. This means that investors can purchase fewer Class A Shares for the same initial investment than Class B Shares or Class C Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class B Shares impose a maximum contingent deferred sales charge ("CDSC") of 5.00%. In addition, Class B Shares impose a CDSC on most redemptions made within seven years of purchase, have distribution costs resulting from Rule 12b-1 distribution fees of 0.75 of 1% and a shareholder services fee of 0.25 of 1%. In addition, at the end of the seven year period, Class B Shares may automatically convert to Class A Shares and thus be subject to lower Rule 12b-1 distribution fees. Class C Shares impose a CDSC of 1.00 of 1% on most redemptions made within the first 12 months of purchase, have a Rule 12b-1 distribution fee of 0.75 of 1%, and a shareholder services fee of 0.25 of 1% This means that investors may purchase more Class B Shares or Class C Shares than Class A Shares for the same initial investment, but will receive lower dividends per Share. Investors should consider whether, during the anticipated life of their investment in the Fund, the accumulated Rule 12b-1 fee, CDSC, and shareholder services fee on either Class B Shares or Class C Shares would be less than the initial sales charge and accumulated Rule 12b-1 fee on Class A Shares purchased at the same time. Investors must also consider how each differential would be offset by the higher yield of Class A Shares. SHARE PRICE CALCULATION The net asset value of a Fund Share equals the market value of all the Fund's portfolio securities divided by the total Shares outstanding. It is also the bid price. The offering price is quoted after adding a sales charge to the net asset value. Purchases, redemptions, and exchanges are all based on net asset value. (The purchase price of Class A Shares adds an applicable sales charge, and the redemption proceeds of Class B Shares and Class C Shares deduct an applicable CDSC.) The net asset value is determined at 4:00 p.m. (Eastern time), Monday through Friday, except on: (i) days on which there are not sufficient changes in the value of a Fund's portfolio securities that its net asset value might be materially affected; (ii) days during which no Shares are tendered for redemption and no orders to purchase Shares are received; and (iii) the following holidays: New Year's Day, Martin Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Columbus Day, Veterans' Day, Thanksgiving Day, and Christmas Day. The net asset value is computed by adding cash and other assets to the closing market value of all securities owned, subtracting liabilities and dividing the result by the number of outstanding Shares. The net asset value will vary each day depending on purchases and redemptions. Expenses and fees, including the management fee, are accrued daily and taken into account for the purpose of determining net asset value. The net asset value of Y Shares of a Fund may differ slightly from that of Class A Shares, Class B Shares, and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges and shareholder services fees (in the case of Class B Shares and Class C Shares) for each class of shares. The net asset value for each Fund will fluctuate for all four classes. PERFORMANCE INFORMATION A Fund's performance may be quoted in terms of total return and yield. Performance information is historical and is not intended to indicate future results. From time to time, the Funds may make available certain information about the performance of Class A Shares, Class B Shares, and Class C Shares. It is generally reported using total return and yield. Total return takes into account both income (dividends) and changes in the Fund's Share price (appreciation or depreciation). It is based on the overall dollar or percentage change in value of an investment assuming reinvestment of all dividends and capital gains during a specified period. Total return is measured by comparing the value of an investment at the beginning of a specified period to the redemption value at the end of the same period, assuming reinvestment of dividends or capital gains distributions. Yield shows how much income an investment generates. It refers to the Fund's income over a 30-day period expressed as a percentage of the Fund's Share price. The yields of Class A Shares, Class B Shares and Class C Shares are calculated by dividing the sum of all interest and dividend income (less Fund expenses) over a 30-day period by the offering price per Share on the last day of the period. The number is then annualized using semi-annual compounding. The yield does not necessarily reflect income actually earned by Class A Shares, Class B Shares and Class C Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Performance information for the Class A Shares, Class B Shares and Class C Shares reflects the effect of a sales charge which, if excluded, would increase the total return and yield. Total return and yield will be calculated separately for Class A Shares, Class B Shares, Class C Shares and Y Shares of a Fund. Because Class A Shares are subject to 12b-1 fees, and Class B Shares and Class C Shares are subject to a 12b-1 fee and a shareholder services fee, the yield will be lower than that of Y Shares. The sales load applicable to Class A Shares also contributes to a lower total return for Class A Shares. In addition, Class B Shares and Class C Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class B Shares and Class C Shares, respectively. From time to time, a Fund may advertise its performance using certain rankings published in financial publications and/or compare its performance to certain indices. HOW TO BUY SHARES Shares may be purchased at a price equal to their net asset value per Share next determined after receipt of an order plus a sales charge which, at the election of the purchaser, may be imposed either (i) at the time of purchase (in the case of Class A Shares), or (ii) on a contingent deferred basis (in the case of Class B Shares or Class C Shares). MINIMUM INVESTMENT You may invest as often as you want in the Funds. There is a $1,000 minimum initial investment requirement which may be waived in certain situations. For further information, please contact the Mutual Funds Group of First Union Brokerage Services ("FUBS"), a subsidiary of First Union, at 1-800-326-3241. Subsequent investments may be in any amounts. WHAT SHARES COST Class A Shares are sold at their net asset value plus a sales charge as follows:
Sales Charge as Sales Charge as a a Percentage of Percentage of Net Amount of Transaction Public Offering Price Amount Invested --------------------- --------------------- ----------------- $ 0-$ 99,999 4.75% 4.99% $ 100,000-$ 249,999 3.75% 3.90% $ 250,000-$ 499,999 3.00% 3.10% $ 500,000-$ 999,999 2.00% 2.04% $1,000,000-$2,499,999 1.00% 1.01% $2,500,000+ 0.25% 0.25%
Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate families, will be exempt from sales charges on any future purchases in any of the First Union Funds. Employees of First Union, Federated Securities Corp. (the "distributor" or "FSC") and their affiliates, and certain trust accounts for which First Union or its affiliates act in an administrative, fiduciary, or custodial capacity, board members of First Union and the above-mentioned entities and the members of the immediate families of any of these persons, will also be exempt from sales charges. Sales charges may be reduced in some cases. You may be entitled to a reduction if: (1) you make a single large purchase, (2) you, your spouse and/or children (under 21 years) make Fund purchases on the same day, (3) you make an additional purchase to add to an existing account, (4) you sign a letter of intent indicating your intention to purchase at least $100,000 of Shares over the next 13 months, (5) you reinvest in a Fund within 30 days of redemption, or (6) you combine purchases of two or more First Union Funds which include front- end sales charges. In addition, no front-end sales charges are imposed on Class A Shares purchased by institutional investors, which may include bank trust departments and registered investment advisers, and through qualified and non- qualified employee benefit and savings plans which make Shares of the First Union Funds available to their participants, and which: (a) are employee benefit plans having at least $1,000,000 in investable assets, or 250 or more eligible participants; or (b) are non-qualified benefit or profit sharing plans which are sponsored by an organization which also makes the First Union Funds available through a qualified plan meeting the criteria specified under (a). Payments may be made to broker/dealers or other financial intermediaries whose employee benefit plan clients purchase Shares under the foregoing front-end sales charge exemption in an amount up to .50 of 1% of the net asset value of the Class A Shares purchased. These payments are subject to reclaim in the event the Class A Shares are redeemed within 12 months after purchase. In all of these cases, you must notify the distributor of your intentions in writing in order to qualify for a sales charge reduction. For more information, consult the Funds' Statement of Additional Information or the distributor. Class B Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within seven years of their purchase will be subject to a CDSC according to the following schedule:
Year of Redemption Contingent Deferred After Purchase Sales Charge ------------------ ------------------- First 5.0% Second 4.0% Third 3.0% Fourth 3.0% Fifth 2.0% Sixth 1.0% Seventh 1.0%
Class C Shares are sold at net asset value per Share without the imposition of a sales charge at the time of purchase. Shares redeemed within one year of their purchase will be subject to a CDSC of 1.00%. With respect to Class B Shares and Class C Shares, no CDSC will be imposed on: (1) the portion of redemption proceeds attributable to increases in the value of the account due to increases in the net asset value per Share, (2) Shares acquired through reinvestment of dividends and capital gains, (3) Shares held for more than seven years (in the case of Class B Shares) or one year (in the case of Class C Shares) after the end of the calendar month of acquisition, (4) accounts following the death or disability of a shareholder, or (5) minimum required distributions to a shareholder over the age of 70 1/2 from an IRA or other retirement plan. CONVERSION FEATURE Class B Shares include all Shares purchased pursuant to the deferred sales charge alternative which have been outstanding for less than the period ending seven years after the end of the month in which the shareholder's order to purchase Class B Shares was accepted. At the end of this seven year period, Class B Shares may automatically convert to Class A Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class B Shares. Such conversion will be on the basis of the relative net asset values of the two classes, without the imposition of any sales load, fee or other charge. The purpose of the conversion feature is to relieve the holders of the Class B Shares that have been outstanding for a period of time sufficient for the distributor to have been compensated for distribution expenses related to the Class B Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class A Shares, Class B Shares purchased through the reinvestment of dividends and distributions paid on Class B Shares in a shareholder's Fund acount will be considered to be held in a separate sub- account. Each time any Class B Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class A Shares, an equal pro rata portion of the Class B Shares in the sub-account will also convert to Class A Shares. The availability of the conversion feature is subject to the granting of an exemptive order (the "Order") by the SEC or the adoption of a rule permitting such conversion. In the event that the Order or rule ultimately issued by the SEC requires any conditions additional to those described in this prospectus, shareholders will be notified. BY TELEPHONE OR IN PERSON You may purchase Class A Shares, Class B Shares and Class C Shares by telephone from the Mutual Funds Group of FUBS at 1-800-326-3241 or you may place the order in person at any First Union branch location. Shares are sold on days on which the New York Stock Exchange and the Federal Reserve Wire System are open for business. METHOD OF PAYMENT Payment may be made by check or federal funds or by debiting your account at First Union. All purchase orders received prior to 4:00 p.m. (Eastern time) on a regular business day are processed at that day's offering price. Payment is required within five business days. SHAREHOLDER ACCOUNTS As transfer agent for the Funds, Federated Services Company of Pittsburgh, Pennsylvania, with offices in Boston, Massachusetts, maintains a Share account for each shareholder of record. Share certificates are not issued. MINIMUM BALANCE Due to the high cost of maintaining smaller holdings, each Fund reserves the right to redeem a shareholder's Shares if, as a result of redemptions, their aggregate value drops below $1,000. Reductions in value that result solely from market activity will not trigger an involuntary redemption. The Funds will notify shareholders in writing 30 days before taking such action to allow them to increase their holdings to at least the minimum level. DEALER CONCESSION For sales of Shares of the Funds, a dealer will normally receive up to 85% of the applicable sales charge. Any portion of the sales charge which is not paid to a dealer will be retained by the distributor. However, the distributor, in its sole discretion, may uniformly offer to pay to all dealers selling Shares of the Funds, all or a portion of the sales charge it normally retains. If accepted by the dealer, such additional payments will be predicated upon the amount of Fund Shares sold. The sales charge for Shares sold other than through registered broker/dealers will be retained by FSC. FSC may pay fees to banks out of the sales charge in exchange for sales and/or administrative services performed on behalf of the bank's customers in connection with the initiation of customer accounts and purchases of Shares. From time to time, the distributor will conduct sales programs or contests that compensate brokers with cash or non-cash items, such as merchandise and attendance at sales seminars in resort locations. The cost of such compensation is borne by the distributor and is not a Fund expense. HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND As a shareholder, you have the privilege of exchanging your Shares for shares of another First Union Fund. As long as the First Union Fund in which you are invested will not be adversely affected, you may switch among the First Union Funds within the Trust. Before the exchange, you must call FUBS at 1-800-326-3241 to receive a prospectus for the First Union Fund into which you want to exchange. Read the prospectus carefully. Each exchange represents the sale of shares of one First Union Fund and the purchase of shares in another, which may produce a gain or loss for tax purposes. You may exchange Class A Shares of one First Union Fund for Class A Shares of any other First Union Fund, Class B Shares of one First Union Fund for Class B Shares of any other First Union Fund, or Class C Shares of one First Union Fund for Class C Shares of any other First Union Fund by calling toll free 1-800- 326-3241 or by writing to FUBS. Telephone exchange instructions may be recorded. Shares purchased by check are eligible for exchange after the check clears, which could take up to seven days after receipt of the check. Exchanges are subject to the $1,000 minimum initial purchase requirement for each First Union Fund. An exchange order must comply with the requirements for a redemption and purchase order and must specify the dollar value or number of shares to be exchanged. Once the order is received, the Shares already owned will be redeemed at current net asset value and, shares of the other First Union Fund will be purchased at their net asset value determined after the exchange request is received. Orders for exchanges received by a First Union Fund prior to 4:00 p.m. (Eastern time) on any day the First Union Funds are open for business will be executed as of the close of business that day. Orders for exchanges received after 4:00 p.m. (Eastern time) on any business day will be executed at the close of the next business day. When exchanging into and out of load and no-load shares of First Union Funds, shareholders who have already paid a sales charge once at the time of purchase, including shares obtained through the reinvestment of dividends, will not have to pay an additional sales charge on an exchange. The exchange of Class B Shares or Class C Shares will not be subject to a CDSC. However, if the shareholder redeems Class B Shares within seven years of the original purchase or Class C Shares within one year of the original purchase, a CDSC will be imposed. For purposes of computing the CDSC, the length of time the shareholder has owned Class B Shares or Class C Shares will be measured from the date of original purchase and will not be affected by the exchange. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. EXCHANGE RESTRICTIONS Although the Trust has no intention of terminating or modifying the exchange privilege, it reserves the right to do so at any time. Excessive trading can impact the interests of shareholders. Therefore, the Trust reserves the right to terminate the exchange privilege of any shareholder who makes more than five exchanges of shares of the First Union Funds in a year or three exchanges in a calendar quarter. The exchange privilege is only available in states where shares of the First Union Fund being acquired may legally be sold. Before the exchange, a shareholder must receive a prospectus of the First Union Fund for which the exchange is being made. HOW TO REDEEM SHARES Shares are redeemed at their net asset value next determined after a proper redemption request has been received, less, in the case of Class B Shares or Class C Shares, any applicable CDSC. You may redeem Shares in three ways: (1) by telephoning FUBS at 1-800-326- 3241, (2) by written request to FUBS or Federated Services Company, c/o State Street Bank and Trust Company, P.O. Box 8609, Boston, Massachusetts 02266- 8609, or (3) in person at First Union. Telephone redemption instructions may be recorded. The Funds redeem Shares at their net asset value next determined after a Fund receives the redemption request. Redemptions will be made on days on which a Fund computes the net asset value of Shares. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Proceeds will be wired to the shareholder's account at First Union or a check will be sent to the address of record, normally within five (but in no case longer than seven) days after a proper request for redemption has been received. If reasonable procedures are not followed by a Fund, it may be liable for losses due to unauthorized or fraudulent telephone instructions. ADDITIONAL SHAREHOLDER SERVICES TELEPHONE SERVICES You may authorize electronic transfers of money to purchase Shares in any amount or to redeem any or all Shares in an account. The service may be used like an "electronic check" to move money between a bank account and an account in a Fund with a single telephone call. SYSTEMATIC INVESTMENT PLAN You may arrange for systematic monthly or quarterly investments in your account in amounts of $25 or more by directly debiting your bank account. TAX SHELTERED PLANS You may open a pension and profit sharing account in any First Union Fund (except those First Union Funds having an objective of providing tax free income), including Individual Retirement Accounts ("IRAs"), Rollover IRAs, Keogh Plans, Corporate Profit-Sharing, Pension and Salary-Reduction Plans. For details, including fees and application forms, call First Union toll free at 1- 800-669-2136 or write to First Union National Bank of North Carolina, Retirement Services, 301 South College Street, Charlotte, NC 28288-1169. SYSTEMATIC CASH WITHDRAWAL PLAN When an account of $10,000 or more is opened or when an existing account reaches that size, you may participate in a Fund's Systematic Cash Withdrawal Plan by filling out the appropriate part of the share purchase application. Under this Plan, you may receive (or designate a third party to receive) a monthly or quarterly check in a stated amount of not less than $25. Fund Shares will be redeemed as necessary to meet withdrawal payments. All participants must elect to have their dividends and capital gain distributions reinvested automatically. Any applicable Class B CDSC will be waived with respect to redemptions occurring under a Systematic Cash Withdrawal Plan during a calendar year to the extent that such redemptions do not exceed 10% of (i) the initial value of the account, plus (ii) the value, at the time of purchase, of any subsequent investments. MANAGEMENT OF FIRST UNION FUNDS Responsibility for the overall management of First Union Funds rests with its Trustees and officers. Other service providers include the Funds' Distributor, Investment Adviser, Sub-Advisers, Custodian, Transfer Agent, Legal Counsel, and Independent Auditors. INVESTMENT ADVISER Professional investment supervision for the Funds is provided by the investment adviser, the Capital Management Group of First Union. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina, with $77.3 billion in total consolidated assets as of December 31, 1994. Through offices in 42 states and two foreign countries, First Union Corporation and its subsidiaries provide a broad range of financial services to individuals and businesses. First Union's Capital Management Group employs an experienced staff of professional investment analysts, portfolio managers, and traders, and uses several proprietary computer-based systems in conjunction with fundamental analysis to identify investment opportunities. The Capital Management Group has been managing trust assets for over 50 years and currently oversees assets of more than $51.2 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of its regular banking operations, First Union may make loans to public companies. Thus, it may be possible, from time to time, for the Funds to hold or acquire the securities of issuers which are also lending clients of First Union. The lending relationship will not be a factor in the selection of securities. William R. Hackney, III, is Senior Vice President and Chief Investment Officer of the Capital Management Group of First Union National Bank of North Carolina, N.A. Prior to assuming his current position with First Union, Mr. Hackney served as Regional Research Director for E.F. Hutton & Company's Southeast Region. Mr. Hackney has managed the Funds since their inception in September 1994. SUB-ADVISERS Under the terms of the Sub-Advisory Agreements between First Union National Bank and the respective Sub-Advisers, the Sub-Advisers will be responsible for managing that portion or all of each Fund's portfolio as designated by the Adviser, selecting investments for purchase or sale, along with the countries in which each Fund will invest and the dealers in portfolio securities, in accordance with each Fund's investment objectives, policies and limitations as stated herein. EMERGING MARKETS GROWTH FUND Marvin & Palmer Associates, Inc. is Sub-Adviser for the Emerging Markets Growth Fund. Marvin & Palmer, a privately-held company, was founded in 1986 by David F. Marvin and Stanley Palmer. The stock of Marvin & Palmer is owned by Mr. Marvin, Mr. Palmer and seventeen other shareholders. Marvin & Palmer is engaged in the management of global, non-United States and emerging markets equity portfolios for institutional accounts. At June 30, 1994, Marvin & Palmer managed a total of $2.5 billion in investments for 34 institutional investors and 5 commingled funds and served as sub-adviser to another investment company with total assets of $33 million. David F. Marvin is Chairman of the Sub-Adviser and founded the firm, together with Mr. Palmer, in 1986. With respect to the Emerging Markets Growth Fund, Mr. Marvin is primarily responsible for Latin America and currency management, and has served as co-portfolio manager of the Fund since its inception in September 1994. Stanley Palmer is President of the Sub-Adviser and a co-founder of the firm. With respect to the Emerging Markets Growth Fund, Mr. Palmer is, along with Todd D. Marvin, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. Terry B. Mason is a Vice President of and Portfolio Manager for the Sub- Adviser. Before joining the Sub-Adviser in 1990, Mr. Mason was employed for 14 years by DuPont Corporation, the last five as an International Equity Analyst and an International Trader. With respect to the Emerging Markets Growth Fund, Mr. Mason is primarily responsible for Eastern Europe and Africa, and has served as co-portfolio manager of the Fund since its inception in September 1994. Jay F. Middleton is a portfolio manager for the Sub-Adviser and joined the firm in 1989. With respect to the Emerging Markets Growth Fund, Mr. Middleton is primarily responsible for Latin America and the Middle East, and has served as co-portfolio manager of the Fund since its inception in September 1994. Todd D. Marvin is a Portfolio Manager for the Sub-Adviser and joined the firm in 1991. Before joining the Sub-Adviser, Mr. Marvin was employed by Oppenheimer & Company as an analyst in its investment banking department from 1989 until 1991. With respect to the Emerging Markets Growth Fund, Mr. Marvin is, along with Mr. Palmer, primarily responsible for Southeast Asia and the India subcontinent, and has served as co-portfolio manager of the Fund since its inception in September 1994. INTERNATIONAL EQUITY FUND Boston International Advisors, Inc. is Sub-Adviser for the International Equity Fund. Boston International commenced operations in 1986 and specializes in the management of international equity portfolios. Boston International manages eighteen international portfolios, including five group trust funds throughout the world. Messrs. Lyle H. Davis, Norman H. Meltz and David A. Umstead, the principal executive officers of Boston International, each owns more than 25% of the outstanding voting securities of Boston International. As of June 30, 1994, Boston International managed a total of $2.7 billion in assets and served as sub-adviser to one other investment company with total assets of $148 million. Maureen Ghublikian has been a Managing Director of the Sub-Adviser since the firm's inception in 1986. Ms. Ghublikian has served as co-portfolio manager of the Fund since its inception in September 1994. David A. Umstead was a founder and has been a Managing Director of the Sub- Adviser since the firm's inception in 1986. Mr. Umstead has served as co- portfolio manager of the Fund since its inception in September 1994. DISTRIBUTION OF INVESTMENT SHARES FSC, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, is the principal distributor for the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Each class of Investment Shares of a Fund has adopted a separate plan for distribution of Shares permitted by Rule 12b-1 under the Investment Company Act of 1940 (the "Plans"), whereby each Fund has authorized a daily expense ("Rule 12b-1 fee") at an annual rate of up to 0.75 of 1% of the average daily net asset value of that Fund's respective class to finance the sale of Shares. It is currently intended that annual Rule 12b-1 fees will be limited for the foreseeable future to payments to the distributor equal to 0.25 of 1% for Class A Shares of the Emerging Markets Growth and International Equity Funds and 0.75% for Class B Shares and Class C Shares of each Fund's respective average daily net asset value. The distributor may pay all or a portion of the Rule 12b-1 fee to compensate selected brokers and financial institutions for selling Shares or for administrative services rendered in connection with the Shares. The Funds make no payments in connection with the sale of Shares other than the Rule 12b-1 fees paid to its distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. Except as set forth in the next paragraph, the Funds do not pay for unreimbursed expenses of the distributor. Since the Funds' Plans are "compensation" type plans, however, future Rule 12b-1 fees may permit recovery of such amounts or may result in a profit to the distributor. The distributor may sell, assign or pledge its right to receive Rule 12b-1 fees and CDSCs to finance payments made to brokers (including FUBS) in connection with the sale of Class B Shares and Class C Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class B Shares and Class C Shares at any given time may exceed the Rule 12b-1 fees and payments received pursuant to CDSCs. These unrecovered amounts, plus interest thereon, will be carried forward and paid from future Rule 12b-1 fees and payments received through CDSCs. If a Plan were terminated or not continued, the Funds would not be contractually obligated to pay for any expenses not previously reimbursed by the Funds or recovered through CDSCs. FSC, from time to time, may pay brokers additional sums of cash or promotional incentives based upon the amount of Shares sold. Such payments, if made, will be in addition to amounts paid under the Plans and will not be an expense of the Funds. FUND ADMINISTRATION Federated Administrative Services ("FAS"), Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, provides the Funds with administrative personnel and services necessary to operate the Funds, such as legal and accounting services, for a specified fee which is detailed below. State Street Bank and Trust Company, Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, Pittsburgh, Pennsylvania, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. Legal counsel to those Trustees who are not "interested persons" of the Trust, as defined in the Investment Company Act of 1940, is provided by Sullivan & Worcester, Washington, D.C. The Funds may pay a shareholder servicing agent (the "Shareholder Servicing Agent") a fee based on average daily net asset value for Class B Shares and Class C Shares of the Funds for which the Shareholder Servicing Agent provides shareholder services. As such, the Shareholder Servicing Agent provides shareholder services which include, but are not limited to: distributing prospectuses and other information, providing shareholder assistance, and communicating or facilitating purchases and redemptions of Class B Shares and Class C Shares. The Funds may pay the Shareholder Servicing Agent a fee equal to 0.25 of 1% of the average daily net asset value of Class B Shares and Class C Shares for which the Shareholder Servicing Agent provides shareholder services. The Shareholder Servicing Agent may voluntarily choose to waive all or a portion of its fee at any time. First Union Brokerage Services, First Union National Bank of North Carolina, and other financial institutions may serve as Shareholder Servicing Agent. The independent auditors for the Trust are KPMG Peat Marwick LLP, Pittsburgh, Pennsylvania. FEES AND EXPENSES Each Fund pays annual advisory and administrative fees and certain expenses. ADVISORY, SUB-ADVISORY, AND ADMINISTRATIVE FEES For managing their investment and business affairs, the Funds pay an annual fee to First Union. The Adviser may voluntarily choose to waive a portion of its fee or reimburse the Funds for certain operating expenses. The Adviser receives an annual investment advisory fee with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- 1.50% on the first $100 million 1.45% on the next $100 million 1.40% on the next $100 million 1.35% on assets in excess of $300 million
International Equity Fund
Average Aggregate Advisory Fee Daily Net Assets ------------ ----------------- .82% on the first $20 million .79% on the next $30 million .76% on the next $50 million .73% on assets in excess of $100 million
The fees paid by the Emerging Markets Growth Fund and the International Equity Fund are higher than the advisory fees paid by other mutual funds in general; however, the fees paid by the International Equity Fund are comparable to fees paid by many mutual funds with similar investment objectives and policies. For its services under its Sub-Advisory Contract with the Adviser, each Sub- Adviser receives a monthly fee calculated on an annual basis, payable by the Adviser, for its services and expenses incurred with respect to the Emerging Markets Growth Fund and the International Equity Fund, respectively: Emerging Markets Growth Fund--Marvin & Palmer
Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- 1.00% on the first $100 million .95% on the next $100 million .90% on the next $100 million .85% on assets in excess of $300 million
International Equity Fund--Boston International
Average Aggregate Sub-Advisory Fee Daily Net Assets ---------------- ----------------- .32% on the first $20 million .29% on the next $30 million .26% on the next $50 million .23% on assets in excess of $100 million
The Trust also pays a fee for administrative services. FAS provides these at an annual rate as specified below:
Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust ------------------- --------------------------- .150 of 1% on the first $250 million .125 of 1% on the next $250 million .100 of 1% on the next $250 million .075 of 1% on assets in excess of $750 million
Unless waived, the administrative fee received during any fiscal year shall aggregate at least $50,000 per First Union Fund. EXPENSES OF THE FUNDS AND INVESTMENT SHARES Holders of Shares pay their allocable portion of Trust and respective Fund expenses. The Trust expenses for which holders of Shares pay their allocable portion include, but are not limited to: the cost of organizing the Trust and continuing its existence; the cost of registering the Trust; Trustees' fees; auditors' fees; the cost of meetings of Trustees; legal fees of the Trust; association membership dues and such non-recurring and extraordinary items as may arise. Fund expenses for which holders of Shares pay their allocable portion based on average daily net assets include, but are not limited to: registering the Fund and Shares of the Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such non-recurring and extraordinary items as may arise. The Funds' expenses under the Rule 12b-1 Plans are incurred by the Class A Shares, Class B Shares and Class C Shares. In addition, the Funds' expenses under a shareholder services plan are incurred solely by the Class B Shares and Class C Shares. The Trustees reserve the right to allocate certain expenses to holders of Shares as they deem appropriate ("Class Expenses"). In any case, Class Expenses would be limited to: Rule 12b-1 fees; shareholder services fees; transfer agent fees; printing and postage expenses; registration fees; and administrative, legal and Trustees' fees. Presently, all Fund expenses, other than Rule 12b-1 fees and shareholder services fees, are allocated based upon the average daily net assets of each class of a Fund. SHAREHOLDER RIGHTS AND PRIVILEGES VOTING RIGHTS Each Share of a Fund is entitled to one vote in Trustee elections and other voting matters submitted to shareholders. All shares of all classes of each First Union Fund in the Trust have equal voting rights, except that in matters affecting only a particular First Union Fund or class, only shares of that First Union Fund or class are entitled to vote. As of February 6, 1995, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 1,471,138 shares (53.26%) and 1,290,972 shares (46.74%), respectively, of International Equity Fund-Y Shares; and First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts was the owner of record of 655,750 shares (84.77%) of the Emerging Markets Growth Fund-Y Shares; and FUBS for the exclusive benefit of George M. Kingsbury, Miami, Florida, and for the exclusive benefit of Julio Noltenius, Julio G. Noltenius, and Alicia Noltenius, El Salvador, acting in various capacities for numerous accounts was the owner of record of 3,510 shares (31.60%) and 5,347 shares (48.14%), respectively, of the Emerging Markets Growth Fund--Class C Investment Shares, and therefore, may, for certain purposes, be deemed to control such Funds and be able to affect the outcome of certain matters presented for a vote of shareholders. As a Massachusetts business trust, the Trust is not required to hold annual shareholder meetings. Shareholder approval will be sought only for certain changes in the Trust or a Fund's operation and for the election of Trustees under certain circumstances. Trustees may be removed by a two-thirds vote of the number of Trustees prior to such removal or by a two-thirds vote of the shareholders at a special meeting. A special meeting of shareholders shall be called by the Trustees upon the written request of shareholders owning at least 10% of the Trust's outstanding shares of all series entitled to vote. MASSACHUSETTS PARTNERSHIP LAW Under certain circumstances, shareholders may be held personally liable under Massachusetts law for acts or obligations of the Trust. To protect shareholders, the Trust has filed legal documents with Massachusetts that expressly disclaim the liability of shareholders for such acts or obligations of the Trust. These documents require notice of this disclaimer to be given in each agreement, obligation, or instrument the Trust or its Trustees enter into or sign. In the unlikely event a shareholder is held personally liable for the Trust's obligations, the Trust is required, by the Declaration of Trust, to use the property of the Trust to protect or compensate the shareholder. On request, the Trust will defend any claim made and pay any judgment against a shareholder for any act or obligation of the Trust. Therefore, financial loss resulting from liability as a shareholder will occur only if the Trust cannot meet its obligations to indemnify shareholders and pay judgments against them from its assets. EFFECT OF BANKING LAWS The Glass-Steagall Act and other banking laws and regulations presently prohibit banks or non-bank affiliates of member banks of the Federal Reserve System from sponsoring, organizing, controlling, or distributing the shares of a registered, open-end investment company continuously engaged in the issuance of its shares. Further, they prohibit banks from issuing, underwriting, or distributing securities in general. Such laws and regulations do not prohibit such a holding company or affiliate from acting as investment adviser, transfer agent, or custodian to such an investment company or from purchasing shares of such a company as agent for and upon the order of their customer. The Adviser, First Union, is subject to and in compliance with such banking laws and regulations. Sullivan & Cromwell has advised First Union that First Union may perform the services for the Funds set forth in the investment advisory agreement, this prospectus, and the Statement of Additional Information without violation of the Glass-Steagall Act or other applicable federal banking laws or regulations. Such counsel has pointed out, however, that changes in federal statutes and regulations relating to the permissible activities of banks, as well as further judicial or administrative decisions or interpretations of such statutes and regulations, could prevent First Union from continuing to perform such services for the Funds or from continuing to purchase Shares for the accounts of its customers. If First Union were prohibited from acting as investment adviser to the Funds, it is expected that the Trustees would recommend to the Funds' shareholders that they approve a new investment adviser selected by the Trustees. It is not expected that the Funds' shareholders would suffer any adverse financial consequences (if another adviser with equivalent abilities to First Union is found) as a result of any of these occurrences. State securities laws governing the ability of depository institutions to act as underwriters or distributors of securities may differ from interpretations given to the Glass-Steagall Act and, therefore, banks and other financial institutions may be required to register as dealers pursuant to state law. DISTRIBUTIONS AND TAXES Each Fund pays out as dividends substantially all of its net investment income (dividends and interest on its investments) and net realized short-term gains. DIVIDENDS Dividends are declared and paid annually for both Funds. Dividends are declared just prior to determining net asset value. Any distributions will be automatically reinvested in additional Shares on payment dates at the ex- dividend date net asset value without a sales charge unless a shareholder otherwise instructs the Fund or FUBS in writing. CAPITAL GAINS Any net long-term capital gains realized by the Funds will be distributed at least once every 12 months. TAX INFORMATION Income dividends and capital gains distributions are taxable as described below. FEDERAL INCOME TAX The Funds pay no federal income tax if they meet the requirements of the Internal Revenue Code, as amended (the "Code") applicable to regulated investment companies and will receive the special tax treatment afforded to such companies. However, the Funds may invest in the stock of certain foreign corporations which would constitute a Passive Foreign Investment Company ("PFIC"). Federal income taxes may be imposed on a Fund upon disposition of PFIC investments. Each First Union Fund is treated as a single, separate entity for federal income tax purposes so that income (including capital gains) and losses realized by one First Union Fund will not be combined for tax purposes with those realized by other First Union Funds. Investment income received by the Funds from sources within foreign countries may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with many foreign countries that entitle the Funds to reduced tax rates or exemptions on this income. The effective rate of foreign tax cannot be predicted since the amount of Fund assets to be invested within various countries will vary. However, the Funds intend to operate so as to qualify for treaty-reduced tax rates, where applicable. Unless otherwise exempt, shareholders are required to pay federal income tax on any dividends and other distributions, whether in shares or cash, for all the Funds. Detailed information concerning the status of dividend and capital gains distributions for federal income tax purposes is mailed to shareholders annually. Distributions representing net long-term capital gains realized by a Fund, if any, will be taxable as long-term capital gains regardless of the length of time shareholders have held their Shares. If more than 50% of the value of a Fund's assets at the end of the tax year is represented by stock or securities of foreign corporations, the Fund intends to qualify for certain Code stipulations that would allow shareholders to claim a foreign tax credit or deduction on their U.S. income tax returns. The Code may limit a shareholder's ability to claim a foreign tax credit. Furthermore, shareholders who elect to deduct their portion of a Fund's foreign taxes rather than take the foreign tax credit must itemize deductions on their income tax returns. Shareholders are urged to consult their own tax advisers regarding the status of their accounts under state and local tax laws. OTHER CLASSES OF SHARES First Union Growth Funds offer four classes of shares: Class A Shares, Class B Shares and Class C Shares for individuals and other customers of First Union, and Y Shares for institutional investors. Y Shares of First Union Growth Funds are sold to accounts for which First Union or other financial institutions act in a fiduciary or agency capacity at net asset value, without a sales charge, at a minimum investment of $1,000. Y Shares are not sold pursuant to a Rule 12b-1 plan. The stated advisory fee is the same for all classes of the Funds. Financial institutions and brokers providing sales and/or administrative services may receive different compensation with respect to one class of shares than with respect to another class of shares of the same Fund. The amount of dividends payable to Class A Shares, Class B Shares and Class C Shares will be less than those payable to Y Shares by the difference between Class Expenses and distribution and shareholder services expenses borne by the shares of each respective class. SHAREHOLDER REPORTS Shareholders receive, in addition to their account statements, periodic reports highlighting relevant financial information for the Trust and the Funds, including investment results and changes in portfolio holdings. In order to reduce the volume of mail that shareholders receive, and to reduce the Funds' printing and postage expenses, only one copy of most Fund reports and annual prospectus updates are mailed to each shareholder household (i.e., an address to which more than one shareholder of record has indicated that mail should be delivered). In the event that a shareholder wishes to receive additional reports or prospectuses, the shareholder should either call FUBS, at 1-800- 3241, or write the Trust. ADDRESSES - -------------------------------------------------------------------------------- First Union Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Distributor Federated Securities Corp. Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Investment Adviser First Union National Bank of North Carolina One First Union Center 301 S. College Street Charlotte, North Carolina 28288 - -------------------------------------------------------------------------------- Sub-Adviser to Emerging Markets Growth Fund Marvin & Palmer Associates, Inc. 1201 North Market Street Suite 2300 Wilmington, Delaware 19801- 1165 - -------------------------------------------------------------------------------- Sub-Adviser to International Equity Fund Boston International Advisors, Inc. 75 State Street Boston, Massachusetts 02109 - -------------------------------------------------------------------------------- Custodian State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Transfer Agent and Dividend Disbursing Agent Federated Services Company Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick LLP One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor G00850-11 (2/95) FIRST UNION EMERGING MARKETS GROWTH PORTFOLIO FIRST UNION INTERNATIONAL EQUITY PORTFOLIO PORTFOLIOS OF FIRST UNION FUNDS Y SHARES CLASS A INVESTMENT SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Y Shares, Class A Investment Shares, Class B Investment Shares, or Class C Investment Shares for First Union Growth Funds, dated February 28, 1995. This Statement is not a prospectus itself. To receive a copy of the Y Shares prospectus, write First Union National Bank of North Carolina, Capital Management Group, 1200 Two First Union Center, Charlotte, North Carolina 28288-1156 or call 1-800-326-2584. To receive a copy of the combined Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares prospectus, write First Union Brokerage Services, Inc., One First Union Center, 301 S. College Street, Charlotte, North Carolina 28288-1173 or call 1-800-326-3241. FEDERATED INVESTORS TOWER PITTSBURGH, PENNSYLVANIA 15222-3779 Statement dated February 28, 1995 [LOGO] FEDERATED SECURITIES CORP. --------------------------------------------------------- Distributor A subsidiary of FEDERATED INVESTORS TABLE OF CONTENTS - -------------------------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUNDS 1 - --------------------------------------------------------------- INVESTMENT OBJECTIVE AND POLICIES 1 - --------------------------------------------------------------- Types of Investments 1 Strategic Investments 2 Foreign Currency Transactions 2 Restricted Securities 4 When-Issued and Delayed Delivery Transactions 4 Lending of Portfolio Securities 4 Repurchase Agreements 4 Reverse Repurchase Agreements 5 Portfolio Turnover 5 Investment Limitations 5 FIRST UNION FUNDS MANAGEMENT 7 - --------------------------------------------------------------- Fund Ownership 9 Trustees Compensation 10 Trustee Liability 10 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Funds 10 Sub-Advisers 10 Advisory Fees 10 Sub-Advisory Fees 11 BROKERAGE TRANSACTIONS 11 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 12 - --------------------------------------------------------------- PURCHASING SHARES 12 - --------------------------------------------------------------- Distribution Plans (Class A, Class B and Class C Investment Shares) 13 Shareholder Services Plan 13 DETERMINING NET ASSET VALUE 14 - --------------------------------------------------------------- Determining Market Value of Securities 14 Trading in Foreign Securities 14 REDEEMING SHARES 14 - --------------------------------------------------------------- Redemption in Kind 14 TAX STATUS 15 - --------------------------------------------------------------- The Funds' Tax Status 15 Foreign Taxes 15 Shareholders' Tax Status 15 TOTAL RETURN 15 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 16 - --------------------------------------------------------------- FINANCIAL STATEMENTS 16 - --------------------------------------------------------------- APPENDIX 17 - --------------------------------------------------------------- GENERAL INFORMATION ABOUT THE FUNDS - -------------------------------------------------------------------------------- First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund") and First Union International Equity Portfolio ("International Equity Fund") (collectively, the "Funds") are portfolios of First Union Funds (the "Trust"). The Trust was established as a Massachusetts business trust under a Declaration of Trust dated August 30, 1984. On January 4, 1993, the name of the Trust was changed from "The Salem Funds" to "First Union Funds." Shares of the Funds are offered in four classes: Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares (individually and collectively referred to as "Shares"). This Combined Statement of Additional Information relates to the above-mentioned Shares of the Funds. INVESTMENT OBJECTIVE AND POLICIES - -------------------------------------------------------------------------------- The combined prospectuses for the Funds discusses each Fund's investment objective and the policies that each Fund employs to achieve its objective. The following discussion supplements the description of each Fund's investment policies in the combined prospectuses. The investment objective of each Fund cannot be changed without approval of shareholders. TYPES OF INVESTMENTS CONVERTIBLE SECURITIES Each Fund may invest in convertible securities. Convertible securities include fixed-income securities that may be exchanged or converted into a predetermined number of shares of the issuer's underlying common stock at the option of the holder during a specified period. Convertible securities may take the form of convertible preferred stock, convertible bonds or debentures, units consisting of "usable" bonds and warrants or a combination of the features of several of these securities. The investment characteristics of each convertible security vary widely, which allow convertible securities to be employed for a variety of investment strategies. Each Fund will exchange or convert convertible securities into shares of underlying common stock when, in the opinion of Marvin & Palmer Associates, Inc. ("Marvin & Palmer"), the sub-adviser to the Emerging Markets Growth Fund or Boston International Advisors, Inc. ("Boston International"), the sub-adviser to the International Equity Fund, the investment characteristics of the underlying common shares will assist a Fund in achieving its investment objective. (Marvin & Palmer and Boston International are individually referred to as a "Sub-Adviser," and collectively referred to as the "Sub-Advisers" in this Combined Statement of Additional Information.) A Fund may also elect to hold or trade convertible securities. In selecting convertible securities, the Sub-Advisers evaluate the investment characteristics of the convertible security as a fixed-income instrument, and the investment potential of the underlying equity security for capital appreciation. In evaluating these matters with respect to a particular convertible security, the Sub-Advisers consider numerous factors, including the economic and political outlook, the value of the security relative to other investment alternatives, trends in the determinants of the issuer's profits, and the issuer's management capability and practices. WARRANTS Each Fund may invest in warrants. Warrants are options to purchase common stock at a specific price (usually at a premium above the market value of the optioned common stock at issuance) valid for a specific period of time. Warrants may have a life ranging from less than one year to twenty years, or they may be perpetual. However, most warrants have expiration dates after which they are worthless. In addition, a warrant is worthless if the market price of the common stock does not exceed the warrant's exercise price during the life of the warrant. Warrants have no voting rights, pay no dividends, and have no rights with respect to the assets of the corporation issuing them. The percentage increase or decrease in the market price of the warrant may tend to be greater than the percentage increase or decrease in the market price of the optioned common stock. Each Fund will not invest more than 5% of the value of its total assets in warrants. No more than 2% of this 5% may be warrants which are not listed on the New York or American Stock Exchanges. Warrants acquired in units or attached to other securities may be deemed to be without value for purposes of this policy. SOVEREIGN DEBT OBLIGATIONS Each Fund may purchase sovereign debt instruments issued or guaranteed by foreign governments or their agencies, including debt of Latin American nations or other developing countries. Sovereign debt may be in the form of conventional securities or other types of debt instruments such as loans or loan participations. Sovereign debt of developing countries may involve a high degree of risk, and may be in default or present the risk of default. Governmental entities responsible for repayment of the debt may be unable or unwilling to repay principal and interest when due, and may require renegotiation or rescheduling of debt payments. In addition, prospects for repayment of principal and interest may depend on political as well as economic factors. CLOSED-END INVESTMENT COMPANIES Each Fund may purchase the equity securities of closed-end investment companies to facilitate investment in certain countries. Equity securities of closed-end investment companies generally trade at a discount to their net asset value. STRATEGIC INVESTMENTS FOREIGN CURRENCY TRANSACTIONS CURRENCY RISKS The exchange rates between the U.S. dollar and foreign currencies are a function of such factors as supply and demand in the currency exchange markets, international balances of payments, governmental intervention, speculation and other economic and political conditions. Although a Fund values its assets daily in U.S. dollars, the Fund may not convert its holdings of foreign currencies to U.S. dollars daily. A Fund may incur conversion costs when it converts its holdings to another currency. Foreign exchange dealers may realize a profit on the difference between the price at which the Fund buys and sells currencies. Each Fund will engage in foreign currency exchange transactions in connection with its portfolio investments. A Fund will conduct its foreign currency exchange transactions either on a spot (i.e., cash) basis at the spot rate prevailing in the foreign currency exchange market or through forward contracts to purchase or sell foreign currencies. FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS Each Fund may enter into forward foreign currency exchange contracts in order to protect against a possible loss resulting from an adverse change in the relationship between the U.S. dollar and a foreign currency involved in an underlying transaction. However, forward foreign currency exchange contracts may limit potential gains which could result from a positive change in such currency relationships. The Sub-Advisers believe that it is important to have the flexibility to enter into forward foreign currency exchange contracts whenever they determine that it is in a Fund's best interest to do so. A Fund will not speculate in foreign currency exchange. A Fund will not enter into forward foreign currency exchange contracts or maintain a net exposure in such contracts when it would be obligated to deliver an amount of foreign currency in excess of the value of its portfolio securities or other assets denominated in that currency or, in the case of a "cross-hedge" denominated in a currency or currencies that the Sub-Adviser believes will tend to be closely correlated with that currency with regard to price movements. Generally, a Fund will not enter into a forward foreign currency exchange contract with a term longer than one year. FOREIGN CURRENCY OPTIONS A foreign currency option provides the option buyer with the right to buy or sell a stated amount of foreign currency at the exercise price on a specified date or during the option period. The owner of a call option has the right, but not the obligation, to buy the currency. Conversely, the owner of a put option has the right, but not the obligation, to sell the currency. When the option is exercised, the seller (i.e., writer) of the option is obligated to fulfill the terms of the sold option. However, either the seller or the buyer may, in the secondary market, close its position during the option period at any time prior to expiration. A call option on a foreign currency generally rises in value if the underlying currency appreciates in value, and a put option on a foreign currency generally falls in value if the underlying currency depreciates in value. Although purchasing a foreign currency option can protect the Fund against an adverse movement in the value of a foreign currency, the option will not limit the movement in the value of such currency. For example, if a Fund was holding securities denominated in a foreign currency that was appreciating and had purchased a foreign currency put to hedge against a decline in the value of the currency, the Fund would not have to exercise its put option. Likewise, if a Fund were to enter into a contract to purchase a security denominated in foreign currency and, in conjunction with that purchase, were to purchase a foreign currency call option to hedge against a rise in value of the currency, and if the value of the currency instead depreciated between the date of purchase and the settlement date, the Fund would not have to exercise its call. Instead, the Fund could acquire in the spot market the amount of foreign currency needed for settlement. SPECIAL RISKS ASSOCIATED WITH FOREIGN CURRENCY OPTIONS Buyers and sellers of foreign currency options are subject to the same risks that apply to options generally. In addition, there are certain additional risks associated with foreign currency options. The markets in foreign currency options are relatively new, and the Funds' ability to establish and close out positions on such options is subject to the maintenance of a liquid secondary market. Although the Funds will not purchase or write such options unless and until, in the opinion of the Sub-Advisers, the market for them has developed sufficiently to ensure that the risks in connection with such options are not greater than the risks in connection with the underlying currency, there can be no assurance that a liquid secondary market will exist for a particular option at any specific time. In addition, options on foreign currencies are affected by all of those factors that influence foreign exchange rates and investments generally. The value of a foreign currency option depends upon the value of the underlying currency relative to the U.S. dollar. As a result, the price of the option position may vary with changes in the value of either or both currencies and may have no relationship to the investment merits of a foreign security. Because foreign currency transactions occurring in the interbank market involve substantially larger amounts than those that may be involved in the use of foreign currency options, investors may be disadvantaged by having to deal in an odd lot market (generally consisting of transactions of less than $1 million) for the underlying foreign currencies at prices that are less favorable than for round lots. There is no systematic reporting of last sale information for foreign currencies or any regulatory requirement that quotations available through dealers or other market sources be firm or revised on a timely basis. Available quotation information is generally representative of very large transactions in the interbank market and thus may not reflect relatively smaller transactions (i.e., less than $1 million) where rates may be less favorable. The interbank market in foreign currencies is a global, around-the-clock market. To the extent that the U.S. option markets are closed while the markets for the underlying currencies remain open, significant price and rate movements may take place in the underlying markets that cannot be reflected in the options markets until they reopen. FOREIGN CURRENCY FUTURES TRANSACTIONS By using foreign currency futures contracts and options on such contracts, a Fund may be able to achieve many of the same objectives as it would through the use of forward foreign currency exchange contracts. The Funds may be able to achieve these objectives possibly more effectively and at a lower cost by using futures transactions instead of forward foreign currency exchange contracts. SPECIAL RISKS ASSOCIATED WITH FOREIGN CURRENCY FUTURES CONTRACTS AND RELATED OPTIONS Buyers and sellers of foreign currency futures contracts are subject to the same risks that apply to the use of futures generally. In addition, there are risks associated with foreign currency futures contracts and their use as a hedging device similar to those associated with options on futures currencies, as described above. Options on foreign currency futures contracts may involve certain additional risks. Trading options on foreign currency futures contracts is relatively new. The ability to establish and close out positions on such options is subject to the maintenance of a liquid secondary market. To reduce this risk, the Funds will not purchase or write options on foreign currency futures contracts unless and until, in the opinion of the Sub-Advisers, the market for such options has developed sufficiently that the risks in connection with such options are not greater than the risks in connection with transactions in the underlying foreign currency futures contracts. Compared to the purchase or sale of foreign currency futures contracts, the purchase of call or put options on futures contracts involves less potential risk to the Funds because the maximum amount at risk is the premium paid for the option (plus transaction costs). However, there may be circumstances when the purchase of a call or put option on a futures contract would result in a loss, such as when there is no movement in the price of the underlying currency or futures contract. - -------------------------------------------------------------------------------- "MARGIN" IN FUTURES TRANSACTIONS Unlike the purchase or sale of a security, the Funds do not pay or receive money upon the purchase or sale of a futures contract. Rather, a Fund is required to deposit an amount of "initial margin" in cash or U.S. Treasury bills with the custodian (or the broker, if legally permitted). The nature of initial margin in futures transactions is different from that of margin in securities transactions, in that futures contracts' initial margin does not involve a borrowing by a Fund to finance the transactions. Initial margin is in the nature of a performance bond or good faith deposit on the contract which is returned to a Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. A futures contract held by a Fund is valued daily at the official settlement price of the exchange on which it is traded. Each day the Funds pay or receive cash, called "variation margin," equal to the daily change in value of the futures contract. This process is known as "marking to market." Variation margin does not represent a borrowing or loan by a Fund but is instead settlement between the Fund and the broker of an amount one would owe the other if the futures contract expired. In computing its daily net asset value, the Funds will mark to market their open futures positions. RESTRICTED SECURITIES The ability of the Board of Trustees (the "Trustees") to determine the liquidity of certain restricted securities is permitted under a Securities and Exchange Commission ("SEC") Staff position set forth in the adopting release for Rule 144A under the Securities Act of 1933 (the "Rule"). The Rule is a non-exclusive, safe-harbor for certain secondary market transactions involving securities subject to restrictions on resale under federal securities laws. The Rule provides an exemption from registration for resales of otherwise restricted securities to qualified institutional buyers. The Rule was expected to further enhance the liquidity of the secondary market for securities eligible for resale under the Rule. The Funds believe that the Staff of the SEC has left the question of determining the liquidity of all restricted securities to the Trustees. The Trustees consider the following criteria in determining the liquidity of certain restricted securities: the frequency of trades and quotes for the security; the number of dealers willing to purchase or sell the security and the number of other potential buyers; dealer undertakings to make a market in the security; and the nature of the security and the nature of marketplace trades. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS These transactions are made to secure what is considered to be an advantageous price or yield for the Funds. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of the Funds sufficient to make payment for the securities to be purchased are segregated on the Funds' records at the trade date. These assets are marked to market daily and are maintained until the transaction has been settled. The Funds do not intend to engage in when-issued and delayed delivery transactions to an extent that would cause the segregation of more than 20% of the total value of their assets. LENDING OF PORTFOLIO SECURITIES The collateral received when a Fund lends portfolio securities must be valued daily and, should the market value of the loaned securities increase, the borrower must furnish additional collateral to the Fund. During the time portfolio securities are on loan, the borrower pays the Funds any dividends or interest paid on such securities. Loans are subject to termination at the option of a Fund or the borrower. The Funds may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the interest earned on the cash or equivalent collateral to the borrower or placing broker. The Funds do not have the right to vote securities on loan, but would terminate the loan and regain the right to vote if that were considered important with respect to the investment. REPURCHASE AGREEMENTS The Funds or their custodian will take possession of the securities subject to repurchase agreements, and these securities will be marked to market daily. To the extent that the original seller does not repurchase the securities from the Funds, the Funds could receive less than the repurchase price on any sale of such securities. In the event that such a defaulting seller filed for bankruptcy or became insolvent, disposition of such securities by the Funds might be delayed pending court action. The Funds believe that under the regular procedures normally in effect for custody of a Fund's portfolio securities subject to repurchase agreements, a court of competent jurisdiction would rule in favor of the Fund and allow retention or disposition of such securities. The Funds will only enter into repurchase agreements with banks and other recognized financial institutions, such as broker/dealers, which are deemed by the Adviser to be creditworthy pursuant to guidelines established by the Trustees. REVERSE REPURCHASE AGREEMENTS The Funds may also enter into reverse repurchase agreements. These transactions are similar to borrowing cash. In a reverse repurchase agreement, the Funds transfer possession of a portfolio instrument to another person, such as a financial institution, broker, or dealer, in return for a percentage of the instrument's market value in cash, and agree that on a stipulated date in the future the Funds will repurchase the portfolio instrument by remitting the original consideration plus interest at an agreed upon rate. The use of reverse repurchase agreements may enable the Funds to avoid selling portfolio instruments at a time when a sale may be deemed to be disadvantageous, but the ability to enter into reverse repurchase agreements does not ensure that the Funds will be able to avoid selling portfolio instruments at a disadvantageous time. When effecting reverse repurchase agreements, liquid assets of a Fund, in a dollar amount sufficient to make payment for the obligations to be repurchased, are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. PORTFOLIO TURNOVER The Funds will not attempt to set or meet a portfolio turnover rate since any turnover would be incidental to transactions undertaken in an attempt to achieve the Funds' investment objectives. It is not anticipated that the portfolio trading engaged in by the Emerging Markets Growth Fund and the International Equity Fund will result in its annual rate of turnover exceeding 50% and 50%, respectively. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Emerging Markets Growth Fund's portfolio turnover rate was 17%. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the International Equity Fund's portfolio turnover rate was 1%. INVESTMENT LIMITATIONS DIVERSIFICATION OF INVESTMENTS With respect to 75% of the value of its assets, each Fund will not purchase the securities of any issuer (other than cash, cash items, or securities issued or guaranteed by the U.S. government, its agencies, or instrumentalities and repurchase agreements collateralized by such securities) if, as a result, more than 5% of the value of its total assets would be invested in the securities of that issuer, or if it would own more than 10% of the outstanding voting securities of any one issuer. ISSUING SENIOR SECURITIES AND BORROWING MONEY Each Fund will not issue senior securities, except that a Fund may borrow money directly or through reverse repurchase agreements in amounts up to one-third of the value of its total assets, including the amount borrowed and except to the extent that a Fund may enter into futures contracts. A Fund will not borrow money or engage in reverse repurchase agreements for investment leverage, but rather as a temporary, extraordinary, or emergency measure to facilitate management of the portfolio by enabling the Fund to meet redemption requests when the liquidation of portfolio securities is deemed to be inconvenient or disadvantageous. A Fund will not purchase any securities while borrowings in excess of 5% of its total assets are outstanding. SELLING SHORT AND BUYING ON MARGIN Each Fund will not sell any securities short or purchase any securities on margin, but may obtain such short-term credits as may be necessary for the clearance of purchases and sales of securities. A deposit or payment by a Fund of initial or variation margin in connection with financial futures contacts or related options transactions is not considered the purchase of a security on margin. UNDERWRITING Each Fund will not underwrite any issue of securities, except as it may be deemed to be an underwriter under the Securities Act of 1933 in connection with the sale of securities in accordance with its investment objective, policies, and limitations. CONCENTRATION OF INVESTMENTS Each Fund will not invest 25% or more of the value of its total assets in any one industry, except that it may invest more than 25% of its total assets in securities issued or guaranteed by the U.S. government, its agencies or instrumentalities. INVESTING IN REAL ESTATE Each Fund will not purchase or sell real estate, including limited partnership interests in real estate, although it may invest in securities of companies whose business involves the purchase or sale of real estate or in securities which are secured by real estate or interests in real estate. INVESTING IN COMMODITIES Each Fund will not invest in commodities, except that each Fund reserves the right to engage in transactions involving futures contracts, options, and forward contracts with respect to securities, securities indexes or currencies. PLEDGING ASSETS Each Fund will not mortgage, pledge, or hypothecate any assets, except to secure permitted borrowings. In those cases, it may pledge assets having a market value not exceeding the lesser of the dollar amounts borrowed or 15% of the value of total assets at the time of the borrowing. For purposes of this limitation, the following are not deemed to be pledges: margin deposits for the purchase and sale of financial futures contracts and related options; and segregation or collateral arrangements made in connection with options activities or the purchase of securities on a when-issued basis. LENDING CASH OR SECURITIES Each Fund will not lend any of its assets, except portfolio securities up to one-third of the value of its total assets. This shall not prevent the Fund from purchasing or holding corporate or government bonds, debentures, notes, certificates of indebtedness or other debt securities of an issuer, repurchase agreements, or other transactions which are permitted by a Fund's investment objective and policies or the Trust's Declaration of Trust. The above investment limitations cannot be changed without shareholder approval. The following limitations, however, may be changed by the Trustees without shareholder approval. Shareholders will be notified before any material changes in these limitations become effective. INVESTING IN RESTRICTED SECURITIES Each Fund will not invest more than 5% of its total assets in securities subject to restrictions on resale under the Securities Act of 1933, except for restricted securities which meet the criteria for liquidity as established by the Trustees. INVESTING IN ILLIQUID SECURITIES Each Fund will not invest more than 15% of its net assets in illiquid securities, including repurchase agreements providing for settlement more than seven days after notice, non-negotiable time deposits, and certain restricted securities not determined by the Trustees to be liquid. INVESTING IN NEW ISSUERS Each Fund will not invest more than 5% of its total assets in securities of issuers which have records of less than three years of continuous operations, including their predecessors. INVESTING IN WARRANTS Each Fund will not invest more than 5% of its net assets in warrants, including those acquired in units or attached to other securities. To comply with certain state restrictions, a Fund will limit its investment in such warrants not listed on the New York or American Stock Exchanges to 2% of its net assets. (If state restrictions change, this latter restriction may be revised without notice to shareholders.) For purposes of this investment restriction, warrants will be valued at the lower of cost or market, except that warrants acquired by a Fund in units with or attached to securities may be deemed to be without value. INVESTING IN OPTIONS Each Fund may write covered call options and secured put options on up to 25% of its net assets and may purchase put and call options provided that no more than 5% of the fair market value of its net assets may be invested in premiums on such options. INVESTING IN SECURITIES OF OTHER INVESTMENT COMPANIES Each Fund will limit its investment in other investment companies to no more than 3% of the total outstanding voting stock of any investment company, will invest no more than 5% of its total assets in any one investment company, and will invest no more than 10% of its total assets in investment companies in general. A Fund will purchase securities of closed-end investment companies only in open- market transactions involving customary broker's commissions. However, these limitations are not applicable if the securities are acquired in a merger, consolidation, or acquisition of assets. It should be noted that investment companies incur certain expenses such as management fees, and, therefore, any investment by a Fund in shares of another investment company would be subject to such duplicate expenses. INVESTING IN MINERALS Each Fund will not purchase interests in oil, gas, or other mineral exploration or development programs, or leases, although it may purchase the securities of issuers which invest in or sponsor such programs. INVESTING IN ISSUERS WHOSE SECURITIES ARE OWNED BY OFFICERS AND TRUSTEES OF THE TRUST Each Fund will not purchase or retain the securities of any issuer if the officers and Trustees of the Trust, its investment adviser, or the Sub-Advisers, owning individually more than 1/2 of 1% of the issuer's securities, together own more than 5% of the issuer's securities. Except with respect to borrowing money, if a percentage limitation is adhered to at the time of investment, a later increase or decrease in percentage resulting from any change in value of net assets will not result in a violation of such restriction. To comply with registration requirements in certain states, each Fund will limit the margin deposits on futures contracts entered into by a Fund to 5% of its net assets. (If state requirements change, these restrictions may be revised without shareholder notification.) Each Fund has no present intention to borrow money or enter into reverse repurchase agreements in excess of 5% of the value of its net assets during the coming fiscal year. For purposes of its policies and limitations, the Funds consider certificates of deposit and demand and time deposits issued by a U.S. branch of a domestic bank or savings and loan having capital, surplus, and undivided profits in excess of $100,000,000 at the time of investment to be "cash items." FIRST UNION FUNDS MANAGEMENT - -------------------------------------------------------------------------------- Officers and Trustees are listed with their addresses, principal occupations, and present positions. Each of the Trustees of First Union Funds listed below, with the exception of Edward C. Gonzales, also serves as a trustee of the Evergreen Family of Mutual Funds, a group of investment companies that is advised by Evergreen Asset Management Corp., a wholly-owned subsidiary of First Union National Bank of North Carolina, N.A. - -------------------------------------------------------------------------------- James S. Howell 4124 Crossgate Road Charlotte, NC Birthdate: August 13, 1924 Chairman and Trustee of the Trust Retired Vice President of Lance Inc. (food manufacturing). - -------------------------------------------------------------------------------- Gerald M. McDonnell 821 Regency Drive Charlotte, NC Birthdate: July 14, 1939 Trustee of the Trust Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - -------------------------------------------------------------------------------- Thomas L. McVerry 4419 Parview Drive Charlotte, NC Birthdate: August 2, 1938 Trustee of the Trust Business and management adviser (since 1990); formerly, Vice President (1989-1990) and member of the Board of Directors (1988-1990), Rexham Industries, Inc. (diverse manufacturer); and Vice President, Finance and Resources, Rexham Corporation (1979-1990). - -------------------------------------------------------------------------------- William Walt Pettit* Carillon Building Suite 2170 227 West Trade Street Charlotte, NC Birthdate: August 26, 1955 Trustee of the Trust Principal in the law firm Holcomb and Pettit, P.A. (since 1988); formerly with Clontz and Clontz (1980-1988). - -------------------------------------------------------------------------------- Russell A. Salton, III, M.D. Primary Physician Care 1515 Mockingbird Lane Park Seneca Building Suite 300 Charlotte, NC Birthdate: June 2, 1947 Trustee of the Trust Chairman and Medical Director, and formerly, President (1990-1993), Primary PhysicianCare, Inc.; formerly, President, Metrolina Family Practice Group, P.A. (1982-1989). - -------------------------------------------------------------------------------- Michael S. Scofield 212 S. Tryon Street Suite 980 Charlotte, NC Birthdate: February 20, 1943 Trustee of the Trust Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - -------------------------------------------------------------------------------- Edward C. Gonzales* Federated Investors Tower Pittsburgh, PA Birthdate: October 22, 1930 President, Treasurer, and Trustee of the Trust Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Vice President, Treasurer, and Trustee of certain investment companies advised or distributed by affiliates of Federated Investors. - -------------------------------------------------------------------------------- Joseph S. Machi Federated Investors Tower Pittsburgh, PA Birthdate: May 22, 1962 Vice President and Assistant Treasurer of the Trust Vice President, Federated Administrative Services; Director, Private Label Management, Federated Investors; Vice President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Peter J. Germain Federated Investors Tower Pittsburgh, PA Birthdate: September 3, 1959 Secretary of the Trust Corporate Counsel, Federated Investors. - -------------------------------------------------------------------------------- *These Trustees are each deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. FUND OWNERSHIP Officers and Trustees own less than 1% of the Funds' outstanding Shares. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the Emerging Markets Growth Fund: First Union National Bank, Charlotte, North Carolina, owned approximately 655,750 Shares (84.77%) and First Union National Bank, Charlotte, North Carolina, owned approximately 117,758 Shares (15.23%). As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the Emerging Markets Growth Fund. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Emerging Markets Growth Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Kevin W. Smith and Kimberly Smith, Coral Gables, Florida, owned approximately 10,471 Shares (5.09%). As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Emerging Markets Growth Fund: FUBS for the exclusive benefit of Frances B. Goldstein, Charlotte, North Carolina, owned approximately 1,000 Shares (9.00%); FUBS for the exclusive benefit of George M. Kingsbury, Miami, Florida, owned approximately 3,510 Shares (31.60%); and FUBS for the exclusive benefit of Julio Noltenius, Julio G. Noltenius, Alicia Noltenius, El Salvador, owned approximately 5,347 Shares (48.14%). As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Y Shares of the International Equity Fund: First Union National Bank, Charlotte, North Carolina, owned approximately 1,471,138 Shares (53.26%) and First Union National Bank, Charlotte, North Carolina, owned approximately 1,290,972 Shares (46.74%). As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class A Investment Shares of the International Equity Fund. As of February 6, 1995, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the International Equity Fund. As of February 6, 1995, the following shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the International Equity Fund: FUBS, for the exclusive benefit of Charles E. Guarina, Debary, Florida, owned approximately 1,000 shares (5.04%). FUBS for the exclusive benefit of Frances B. Goldstein, Charlotte, North Carolina, owned approximately 1,000 Shares (5.04%); FUBS for the exclusive benefit of Robert T. Pelski, Loxahtchee, Florida, owned approximately 1,050 Shares (5.30%); FUBS for the exclusive benefit of David L. Holt, Dearing, Georgia, owned approximately 1,021 Shares (5.15%); FUBS for the exclusive benefit of Richard K. Hamilton and Sandra H. Hamilton, Dothan, Alabama, owned approximately 2,873 Shares (14.49%); FUBS for the exclusive benefit of C. Wilson Construction Company, Profit Sharing Plan, Bartow, Florida, owned approximately 1,632 Shares (8.23%); and FUBS for the exclusive benefit of G. Gene Wilhelm and Pola Wilhelm, Mooresville, North Carolina, owned approximately 2,688 Shares (13.56%). - -------------------------------------------------------------------------------- TRUSTEES COMPENSATION
AGGREGATE NAME, POSITION COMPENSATION WITH TRUST FROM TRUST*+ James S. Howell, Chairman and Trustee $14,900 Edward C. Gonzales, President, Treasurer and Trustee $0 Gerald M. McDonnell, Trustee $11,900 Thomas L. McVerry, Trustee $11,900 William Walt Pettit, Trustee $11,900 Russell A. Salton, III, M.D., Trustee $11,900 Michael S. Scofield, Trustee $11,700
*Information is furnished for the fiscal year ended December 31, 1994. The Trust is the only investment company in the Fund Complex. +The aggregate compensation is provided for the Trust which is comprised of seventeen portfolios. TRUSTEE LIABILITY The Trust's Declaration of Trust provides that a Trustee shall be liable for his own wilful defaults, but shall not be liable for errors of judgment or mistakes of fact or law. If reasonable care has been exercised in the selection of officers, agents, employees, or investment advisers, a Trustee shall not be liable for any neglect or wrongdoing of any such person. However, a Trustee is not protected against any liability to which he would otherwise be subject by reason of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. INVESTMENT ADVISORY SERVICES - -------------------------------------------------------------------------------- ADVISER TO THE FUNDS The Funds' investment adviser is First Union National Bank of North Carolina (the "Adviser" or "First Union"). It provides investment advisory services through its Capital Management Group. First Union is a subsidiary of First Union Corporation, a bank holding company headquartered in Charlotte, North Carolina. The Adviser shall not be liable to the Trust, the Funds or any shareholder of the Funds for any losses that may be sustained in the purchase, holding, or sale of any security, or for anything done or omitted by it, except acts or omissions involving wilful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Because of the internal controls maintained by First Union to restrict the flow of non-public information, the Funds' investments are typically made without any knowledge of First Union's or its affiliates' lending relationships with an issuer. SUB-ADVISERS Marvin & Palmer and Boston International are the sub-advisers to the Emerging Markets Growth Fund and the International Equity Fund, respectively, under the terms of Sub-Advisory Agreements between First Union and the respective Sub-Adviser. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Adviser earned advisory fees from the Emerging Markets Growth Fund of $35,047, all of which was voluntarily waived. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the Adviser earned advisory fees from the International Equity Fund of $60,885, of which $44,928 was voluntarily waived. - -------------------------------------------------------------------------------- SUB-ADVISORY FEES For their sub-advisory services, Marvin & Palmer and Boston International receive an annual sub-advisory fee as described in the prospectuses. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, Marvin & Palmer Associates, Inc. earned sub-advisory fees from the Emerging Markets Growth Fund of $23,133. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, Boston International Advisors, Inc. earned sub-advisory fees from the International Equity Fund of $23,505. STATE EXPENSE LIMITATIONS The Adviser may be required to undertake to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. In addition, the Funds may seek a waiver from the states imposing these limitations or such amount as may be agreed upon pursuant to the terms of any waiver granted by such states. Should the Funds undertake to meet the limitations imposed by these states, the Adviser would have to agree to reimburse the Funds to the extent that normal operating expenses (including the investment advisory fee, but not including brokerage commissions, interest, taxes, and extraordinary expenses) exceed 2-1/2% per year of the first $30 million of average net assets, 2% per year of the next $70 million of average net assets, and 1-1/2% per year of the remaining average net assets, or such amount as may be established pursuant to the terms of any waiver granted by such states. If the Funds' monthly projected operating expenses exceed this limitation, the investment advisory fee paid will be reduced by the amount of the excess, subject to an annual adjustment. If the expense limitation is exceeded, the amount to be reimbursed by the Adviser will be limited, in any single fiscal year, by the amount of their advisory fees. Pursuant to the Sub-Advisory Agreements between the Adviser and the Sub-Advisers, in the event that the Adviser's fee is reduced in order to meet the expense limitations established by certain states, the sub-advisory fee for the Sub-Adviser to the affected Fund shall be reduced in accordance with the mutual agreement of the Adviser and the Sub-Adviser. BROKERAGE TRANSACTIONS - -------------------------------------------------------------------------------- When selecting brokers and dealers to handle the purchase and sale of portfolio instruments, the Sub-Advisers look for prompt execution of the order at a favorable price. In working with dealers, the Sub-Advisers will generally utilize those who are recognized dealers in specific portfolio instruments, except when a better price and execution of the order can be obtained elsewhere. The Sub-Advisers may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Sub-Advisers make decisions on portfolio transactions and select brokers and dealers subject to review by the Trustees. The Sub-Advisers may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Funds or to the Sub-Advisers and may include: .advice as to the advisability of investing in securities; .security analysis and reports; .economic studies; .industry studies; .receipt of quotations for portfolio evaluations; and .similar services. The Sub-Advisers and their affiliates exercise reasonable business judgment in selecting brokers who offer brokerage and research services to execute securities transactions. They determine in good faith that commissions charged by such persons are reasonable in relationship to the value of the brokerage and research services provided. Research services provided by brokers and dealers may be used by the Sub-Advisers in advising the Funds and other accounts. To the extent that receipt of these services may supplant services for which the Sub-Advisers or their affiliates might otherwise have paid, it would tend to reduce their expenses. Although investment decisions for the Funds are made independently from those of the other accounts managed by the Sub-Advisers, investments of the type the Funds may make may also be made by those other accounts. When the Funds and one or more other accounts managed by the Sub-Advisers are prepared to invest in, or desire to dispose of, the same security, available investments or opportunities for sales will be allocated in a manner believed by the Sub-Advisers to be equitable to each. In some cases, this procedure may adversely affect the price paid or received by the Funds or the size of the position obtained or disposed of by the Funds. In other cases, however, it is believed that coordination and the ability to participate in volume transactions will be to the benefit of the Funds. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Emerging Markets Growth Fund paid $41,532 in commissions on brokerage transactions. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the International Equity Fund paid $16,640 in commissions on brokerage transactions. ADMINISTRATIVE SERVICES - -------------------------------------------------------------------------------- Federated Administrative Services, a subsidiary of Federated Investors, provides administrative personnel and services to each Fund for a fee as described in the respective prospectus. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Emerging Markets Growth Fund incurred $15,890 in administrative service costs, all of which was waived. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the International Equity Fund incurred $16,438 in administrative service costs, all of which was waived. PURCHASING SHARES - -------------------------------------------------------------------------------- Shares are sold at their net asset value, plus a sales charge, if applicable, on days the New York Stock Exchange and the Federal Reserve Wire System are open for business. The procedure for purchasing Shares is explained in the respective prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of Class A Investment Shares through: quantity discounts and accumulated purchases; signing a 13-month letter of intent; using the reinvestment privilege; or concurrent purchases. QUANTITY DISCOUNTS AND ACCUMULATED PURCHASES Larger purchases reduce the sales charge paid. A Fund will combine purchases of Shares made on the same day by the investor, his spouse, and his children under age 21 when it calculates the sales charge. If an additional purchase of Shares is made, a Fund will consider the previous purchases still invested in the Fund. For example, if a shareholder already owns Shares having a current value at the public offering price of $90,000, and then purchases $10,000 more at the current public offering price, the sales charge on the additional purchase according to the schedule now in effect would be 3.75%, not 4.75%. To receive the sales charge reduction, Federated Securities Corp. ("FSC") must be notified by the shareholder in writing at the time the purchase is made that Shares are already owned or that purchases are being combined. A Fund will reduce the sales charge after it confirms the purchases. LETTER OF INTENT If a shareholder intends to purchase at least $100,000 of Shares in a Fund over the next 13 months, the sales charge may be reduced by signing a letter of intent to that effect. This letter of intent includes a provision for a sales charge adjustment depending on the amount actually purchased within the 13-month period and a provision for the custodian to hold up to 4.75% of the total amount intended to be purchased in escrow (in Shares) until such purchase is completed. The amount held in escrow will be applied to the shareholder's account at the end of the 13-month period, unless the amount specified in the letter of intent is not purchased. In this event, an appropriate number of escrowed Shares may be redeemed in order to realize the difference in the sales charge. This letter of intent will not obligate the shareholder to purchase Shares, but if the shareholder does, each purchase during the period will be at the sales charge applicable to the total amount intended to be purchased. This letter may be dated as of a prior date to include any purchases made within the past 90 days. REINVESTMENT PRIVILEGE If Shares in a Fund have been redeemed, the shareholder has a one-time right, within 30 days, to reinvest the redemption proceeds at the next-determined net asset value without any sales charge. FSC must be notified by the shareholder in writing or by his financial institution of the reinvestment in order to eliminate a sales charge. If the shareholder redeems his Shares in a Fund, there may be tax consequences. CONCURRENT PURCHASES For purposes of qualifying for a sales charge reduction, a shareholder has the privilege of combining concurrent purchases of two or more First Union Funds in the Trust, the purchase price of which includes a sales charge. For example, if a shareholder concurrently invested $30,000 in Shares of one of the other First Union Funds with a sales charge, and $70,000 in Shares of another Fund, the sales charge would be reduced. To receive this sales charge reduction, FSC must be notified by the shareholder in writing or by his financial institution at the time the concurrent purchases are made. A Fund will reduce the sales charge after it confirms the purchases. DISTRIBUTION PLANS (CLASS A, CLASS B, AND CLASS C INVESTMENT SHARES) With respect to the Class A, Class B, and Class C Investment Shares classes of the Funds, the Trust has adopted distribution plans (the "Plans") pursuant to Rule 12b-1 which was promulgated by the SEC pursuant to the Investment Company Act of 1940. The Plans permit the payment of fees to brokers for distribution and administrative services and to administrators for administrative services as to Class A, Class B, and Class C Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Funds and holders of Class A, Class B, and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Funds and holders of Class A, Class B, and Class C Investment Shares. The administrative services are provided by a representative who has knowledge of the shareholder's particular circumstances and goals, and include, but are not limited to: providing office space, equipment, telephone facilities, and various personnel, including clerical, supervisory, and computer, as necessary or beneficial to establish and maintain shareholder accounts and records; processing purchase and redemption transactions and automatic investments of client account cash balances; answering routine client inquiries regarding Class A, Class B, and Class C Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Funds reasonably request for their Class A, Class B, and Class C Investment Shares. By adopting the Plans, the Trustees expect that the Funds will be able to achieve a more predictable flow of cash for investment purposes and to meet redemptions. This will facilitate more efficient portfolio management and assist the Funds in seeking to achieve their investment objectives. By identifying potential investors whose needs are served by the Funds' objectives, and properly servicing these accounts, the Funds may be able to curb sharp fluctuations in rates of redemptions and sales. Other benefits which the Trust hopes to achieve through the Plans include, but are not limited to, the following: (1) an efficient and effective administrative system; (2) a more efficient use of shareholder assets by having them rapidly invested in the Funds, through an automatic transfer of funds from a demand deposit account to an investment account, with a minimum of delay and administrative detail; and (3) an efficient and reliable shareholder records system with prompt responses to shareholders' requests and inquiries concerning their accounts. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Emerging Market Growth Fund incurred $505, $2,924, and $163 for Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares, respectively, pursuant to the Plans. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the International Equity Fund incurred $1,270, $8,718, and $281 for Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares, respectively, pursuant to the Plans. ADMINISTRATIVE ARRANGEMENTS FSC may also pay financial institutions a fee based upon the average net asset value of Shares of their customers for providing administrative services. This fee is in addition to the amounts paid under the Plans for administrative services, and if paid, will be reimbursed by the Adviser and not the Funds. SHAREHOLDER SERVICES PLAN For the period from September 6, 1994 (commencement of operations) to December 31, 1994, the Emerging Markets Growth Fund incurred $975 and $54 for Class B Investment Shares and Class C Investment Shares, respectively, as a shareholder services fee. For the period from September 2, 1994 (commencement of operations) to December 31, 1994, the International Equity Fund incurred $2,906 and $93 for Class B Investment Shares and Class C Investment Shares, respectively, as a shareholder services fee. DETERMINING NET ASSET VALUE - -------------------------------------------------------------------------------- Net asset value of Shares generally changes each day. The days on which the net asset values of Shares are calculated by the Funds are described in the respective prospectus. DETERMINING MARKET VALUE OF SECURITIES The market values of each Fund's portfolio securities, other than options, are determined as follows: .for equity securities, according to the last sale price in the market in which they are primarily traded, if available; .in the absence of recorded sales for equity securities, according to the mean between the last closing bid and asked prices; .for bonds and other fixed income securities, as determined by an independent pricing service; .for short-term obligations, according to the prices as furnished by an independent pricing service, except that short-term obligations with remaining maturities of less than 60 days at the time of purchase may be valued at amortized cost; and .for all other securities, at fair value as determined in good faith by the Trustees. Prices provided by independent pricing services may be determined without relying exclusively on quoted prices and may consider yield, quality, coupon rate, maturity, type of issue, trading characteristics, and other market data. The Funds will value futures contracts and options at their market values established by the Exchanges on which they are traded at the close of trading on such Exchanges, unless the Trustees determine in good faith that another method of valuing such investments is necessary. TRADING IN FOREIGN SECURITIES Trading in foreign securities may be completed at times which vary from the closing of the New York Stock Exchange. In computing the net asset values, the Funds value foreign securities at the latest closing price on the exchange on which they are traded immediately prior to the closing of the New York Stock Exchange. Certain foreign currency exchange rates may also be determined at the latest rate prior to the closing of the New York Stock Exchange. Foreign securities quoted in foreign currencies are translated into U.S. dollars at current rates. Occasionally, events that affect these values and exchange rates may occur between the times at which they are determined and the closing of the New York Stock Exchange. If such events materially affect the value of portfolio securities, these securities may be valued at their fair value as determined in good faith by the Trustees, although the actual calculation may be done by others. REDEEMING SHARES - -------------------------------------------------------------------------------- The Funds redeem Shares at the next computed net asset value after the Fund receives the redemption request, plus a contingent deferred sales charge, if applicable. Redemptions will be made on days on which a Fund computes its net asset values. Redemption requests cannot be executed on days on which the New York Stock Exchange is closed or on federal holidays when wire transfers are restricted. Redemption procedures are explained in the prospectuses under "How to Redeem Shares." REDEMPTION IN KIND The Trust has elected to be governed by Rule 18f-1 of the Investment Company Act of 1940, under which a Fund is obligated to redeem Shares for any one shareholder in cash only up to the lesser of $250,000 or 1% of the respective class's net asset value during any 90-day period. Any redemption beyond this amount will also be in cash unless the Trustees determine that payments should be in kind. In such a case, a Fund will pay all or a portion of the remainder of the redemption in portfolio instruments, valued in the same way as the Fund determines net asset value. The portfolio instruments will be selected in a manner that the Trustees deem fair and equitable. Redemption in kind is not as liquid as a cash redemption. If redemption is made in kind, shareholders receiving their securities and selling them before their maturity could receive less than the redemption value of their securities and could incur certain transaction costs. TAX STATUS - -------------------------------------------------------------------------------- THE FUNDS' TAX STATUS The Funds will pay no federal income tax because they expect to meet the requirements of Subchapter M of the Internal Revenue Code, as amended, applicable to regulated investment companies and to receive the special tax treatment afforded to such companies. To qualify for this treatment, the Funds must, among other requirements: .derive at least 90% of their gross income from dividends, interest, and gains from the sale of securities; .derive less than 30% of their gross income from the sale of securities held less than three months; .invest in securities within certain statutory limits; and .distribute to their shareholders at least 90% of their net income earned during the year. However, the Funds may invest in the stock of certain foreign corporations which would constitute a Passive Foreign Investment Company ("PFIC"). Federal income taxes may be imposed on the Funds upon disposition of PFIC investments. FOREIGN TAXES Investment income on certain foreign securities in which the Funds may invest may be subject to foreign withholding or other taxes that could reduce the return on these securities. Tax treaties between the United States and foreign countries, however, may reduce or eliminate the amount of foreign taxes to which the Funds would be subject. SHAREHOLDERS' TAX STATUS Shareholders are subject to federal income tax on dividends and capital gains received as cash or additional shares. The Funds' dividends, and any short-term capital gains, are taxable as ordinary income. CAPITAL GAINS Shareholders will pay federal income tax at capital gains rates on long-term capital gains distributed to them regardless of how long they have held the Shares. TOTAL RETURN - -------------------------------------------------------------------------------- The Emerging Markets Growth Fund's cumulative total return for Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares for the period from September 6, 1994 (start of performance) to December 31, 1994, was (18.30%), (22.19%), (22.50%), and (19.20%), respectively. The International Equity Fund's cumulative total return for Y Shares, Class A Investment Shares, Class B Investment Shares, and Class C Investment Shares for the period from September 2, 1994 (start of performance) to December 31, 1994, was (5.02%), (9.60%), (9.89%), and (6.09%), respectively. Cumulative total return reflects the Funds' total performance over a specific period of time. This total return assumes and is reduced by the payment of the maximum sales load and any contingent deferred sales charge, if applicable. This total return is representative of only four months of activity since the start of performance. PERFORMANCE COMPARISONS - -------------------------------------------------------------------------------- The performance of all classes of Shares depends upon such variables as: .portfolio quality; .average portfolio maturity; .type of instruments in which the portfolio is invested; .changes in interest rates and market value of portfolio securities; .changes in a Fund's or any class of Shares expenses; and .various other factors. Each class of Shares' performance fluctuates on a daily basis largely because net earnings and offering price per Share fluctuate daily. Both net earnings and offering price per Share are factors in the computation of yield and total return. Investors may use financial publications and/or indices to obtain a more complete view of a Fund's performance. When comparing performance, investors should consider all relevant factors, such as the composition of any index used, prevailing market conditions, portfolio compositions of other funds, and methods used to value portfolio securities and compute offering price. The financial publications and/or indices which the Funds use in advertising may include: .LIPPER ANALYTICAL SERVICES, INC. ("LIPPER"), an independent mutual fund rating service, ranks funds in various fund categories by making comparative calculations using total return. Total return assumes the reinvestment of all capital gains distributions and income dividends and takes into account any change in net asset value over a specified period of time. From time to time, a Fund will quote its Lipper ranking in the appropriate category in advertising and sales literature. .EUROPE, AUSTRALIA, AND FAR EAST ("EAFE") is a market capitalization weighted foreign securities index, which is widely used to measure the performance of European, Australian, New Zealand and Far Eastern stock markets. The index covers approximately 1,020 companies drawn from 18 countries in the above regions. The index values its securities daily in both U.S. dollars and local currency and calculates total returns monthly. EAFE U.S. dollar total return is a net dividend figure less Luxembourg withholding tax. The EAFE is monitored by Capital International, S.A., Geneva, Switzerland. .MORGAN STANLEY CAPITAL INTERNATIONAL ("MSCI") EMERGING MARKETS FREE ("EMF") INDEX is a market capitalization weighted foreign securities index, which is used to measure the performance of developing or emerging markets (as defined by World Bank) in Europe, Asia, Latin America, and the Middle East. MSCI calculates a "Free" and a "Global" version of its EMF Index. The "Free" version excludes those companies and share classes as well as markets, which are closed to foreigners. The "Global" version includes all share classes as well as open and closed markets. The EMF Index covers approximately 1,100 companies from 20 emerging markets described in the regions above. The MSCI EMF Index is currently calculated in local currency and in U.S. dollars, without dividends and with gross dividends reinvested (e.g., before withholding taxes). .MORNINGSTAR, INC., an independent rating service, is the publisher of the bi-weekly Mutual Fund Values. Mutual Fund Values rates more than 1,000 NASDAQ-listed mutual funds of all types, according to their risk-adjusted returns. The maximum rating is five stars, and ratings are effective for two weeks. Advertisements and other sales literature for all classes of Shares may quote total returns which are calculated on non-standardized base periods. These total returns represent the historic change in the value of an investment in any class of Shares based on the annual reinvestment of dividends over a specified period of time. In addition, advertisements and sales literature for a Fund may include charts and other illustrations which depict the hypothetical growth of an investment in a systematic investment plan. Advertisements may quote performance information which does not reflect the effect of the sales load or contingent deferred sales charge, if applicable. Advertising and sales literature for the Funds can include statistics pertaining to the size of U.S. and foreign markets. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Emerging Markets Growth Portfolio and First Union International Equity Portfolio for the fiscal year ended December 31, 1994, are incorporated herein by reference from the Growth Funds' Annual Report, dated December 31, 1994 (File Nos. 2-94560 and 811-4154). A copy of the Annual Report may be obtained without charge by contacting the Fund at the address located on the inside back cover of the respective prospectus. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S RATINGS GROUP LONG-TERM BOND RATINGS DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Rating Group. Capacity to pay interest and repay principal is extremely strong. AA--Debt rated AA has a very strong capacity to pay interest and repay principal and differs from the higher rated issues only in small degree. A--Debt rated A has a strong capacity to pay interest and repay principal although it is somewhat more susceptible to the adverse effect of changes in circumstances and economic conditions than debt in higher rated categories. BBB--Debt rated BBB is regarded as having an adequate capacity to pay interest and repay principal. Whereas it normally exhibits adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for debt in this category than in higher rated categories. MOODY'S INVESTORS SERVICE, INC. LONG-TERM BOND RATING DEFINITIONS AAA--Bonds which are rated AAA are judged to be of the best quality. They carry the smallest degree of investment risk and are generally referred to as "gilt edged." Interest payments are protected by a large or by an exceptionally stable margin and principal is secure. While the various protective elements are likely to change, such changes as can be visualized are most unlikely to impair the fundamentally strong position of such issues. AA--Bonds which are rated AA are judged to be of high quality by all standards. Together with the AAA group, they comprise what are generally known as high grade bonds. They are rated lower than the best bonds because margins of protection may not be as large as in Aaa securities or fluctuation of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in AAA securities. A--Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate but elements may be present which suggest a susceptibility to impairment sometime in the future. BAA--Bonds which are rated BAA are considered as medium-grade obligations, (i.e., they are neither highly protected nor poorly secured). Interest payments and principal security appear to be adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. STANDARD & POOR'S RATINGS GROUP COMMERCIAL PAPER RATING DEFINITIONS A-1--This highest category indicates that the degree of safety regarding timely payment is strong. Those issues determined to possess extremely strong safety characteristics are denoted with a plus sign (+) designation. A-2--Capacity for timely payment on issues with this designation is satisfactory. However, the relative degree of safety is not as high as for issues designated A-1. MOODY'S INVESTORS SERVICE, INC. COMMERCIAL PAPER RATING DEFINITIONS PRIME-1--Issuers rated PRIME-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. PRIME-1 repayment capacity will normally be evidenced by the following characteristics: .Leading market positions in well established industries. .High rates of return on funds employed. .Conservative capitalization structures with moderate reliance on debt and ample asset protection. .Broad margins in earnings coverage of fixed financial markets and assured sources of alternate liquidity. .Well-established access to a range of financial markets and assured sources of alternate liquidity. PRIME-2--Issuers rated PRIME-2 (or related supporting institutions) have a strong capacity for repayment of short-term promissory obligations. This will normally be evidenced by many of the characteristics cited above, but to a lesser degree. Earnings trends and coverage ratios, while sound, will be more subject to variation. Capitalization characteristics, while still appropriate, may be more affected by external conditions. Ample alternative liquidity is maintained. G00850-24 (2/95) PART C. OTHER INFORMATION. Item 24. Financial Statements and Exhibits: (a) Financial Statements: Incorporated into the Statement of Additional Information by reference to the Growth Funds', Growth and Income Funds', Income Funds', Money Market Funds', and Tax Free Funds' Annual Reports. (b) Exhibits: (1) Copy of Declaration of Fund of the Registrant (1); (i) Copy of Amendment to Declaration of Fund (14); (2) Copy of By-Laws of the Registrant (1); (i) Copy of amendment to the By-Laws of the Registrant (3); (3) Not applicable; (4) Copy of Specimen Certificate for Shares of Beneficial Interest of the Registrant (19); (5) Conformed copy of Investment Advisory Contract of the Registrant (21); (i) Conformed copy of Sub-Advisory Agreement between First Union National Bank and Marvin & Palmer Associates, Inc.(21); (ii) Conformed copy of Sub-Advisory Agreement between First Union National Bank and Boston International Advisors, Inc. (21); (6) Conformed copy of Distributor's Contract of the Registrant (21); (i) Conformed copy of the previous Distributors Contract of the Registrant (21); (7) Conformed copy of Administrative Agreement of the Registrant (21); (8) Conformed copy of Custodian Contract of the Registrant (21); + All exhibits have been filed electronically. (1) Response is incorporated by reference to Registrant's Initial Registration Statement on Form N-1A. (File Nos. 2-94560 and 811-4154). (2) Response is incorporated by reference to Registrant's Pre-Effective Amendment No. 1 on Form N-1A (File Nos. 2-94560 and 811-4154). (3) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 3 on Form N-1A (File Nos. 2-94560 and 811-4154). (4) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 4 on Form N-1A (File Nos. 2-94560 and 811-4154). (5) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 11 filed on July 30, 1990 on Form N-1A (File Nos. 2-94560 and 811-4154). (6) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 12 filed on September 7, 1990 on Form N-1A (File Nos. 2- 94560 and 811-4154). (7) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 13 filed on October 4, 1990 on Form N-1A (File Nos. 2- 94560 and 811-4154). (8) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 14 filed on November 6, 1990 on Form N-1A (File Nos. 2- 94560 and 811-4154). (9) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 16 filed on July 18, 1991 on Form N-1A (File Nos. 2-94560 and 811-4154). (10) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 19 filed on February 28, 1992 on Form N-1A (File Nos. 2- 94560 and 811-4154). (11) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 20 filed on August 26, 1992 on Form N-1A (File Nos. 2- 94560 and 811-4154). (12) Response is incorporated by reference to Registrant's Post-Effective Amendment to No. 21 filed on October 30, 1992 on Form N-1A (File Nos. 2- 94560 and 811-4154). (13) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 22 filed on November 23, 1992 on Form N-1A (File Nos. 2- 94560 and 811-4154). (14) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 28 filed on April 15, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (17) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 32 filed on November 2, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (18) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 33 filed on December 29, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (19) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 35 filed on February 25, 1994 on Form N-1A (File Nos. 2- 94560 and 811-4154). (20) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 36 filed on June 28, 1994 on Form N-1A (File Nos. 2-94560 and 811-4154). (21) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 38 filed on December 30, 1994 on Form N-1A (File Nos. 2- 94560 and 811-4154). (9) Conformed copy of the Fund Accounting and Shareholder Recordkeeping Agreement of the Registrant (20); (i) Conformed copy of the previous Transfer Agency and Service Agreement of the Registrant (21); (ii) Conformed copy of Shareholder Services Plan (21); (iii) Conformed copy of Shareholder Services Agreement (21); (10) Copy of Opinion and Consent of Counsel as to legality of shares being registered (8); (11) Copy of Consent of Independent Auditors; + (12) Not applicable; (13) Copy of Initial Capital Understanding (1); (14) Model Plans used in establishment of Retirement Plans (2); (15) (i) Distribution Plan; (a) Copy of First Union Emerging Markets Growth Portfolio and First Union International Equity Portfolio - Class B Investment Shares (21); (i) Copy of First Union South Carolina Municipal Bond Portfolio - Class B Investment Shares (21); (ii) Copy of First Union Virginia Municipal Bond Portfolio, First Union Georgia Municipal Bond Portfolio, First Union Florida Municipal Bond Portfolio - Class B Investment Shares (21); (iii) Copy of First Union Utility Portfolio - Class B Investment Shares (21); (b) First Union Funds - Class C Investment Shares (17); (i) Conformed copy of Exhibit to Class C Investment Shares (21); (c) Conformed copy of First Union Funds - Class D Investment Shares (21); (ii) Rule 12b-1 Agreement (14); (iii) Copy of Amendment Number 5 to 12b-1 Agreement (21); (16) Copy of Schedules for Computation of Fund Performance Data (20.); (i) Copy of Schedules for Computation of Fund Performance Data for First Union Emerging Markets Growth Portfolio and First Union International Equity Portfolio; + (17) Copy of Financial Data Schedules; + (18) Not applicable; (19) Conformed copy of the Power of Attorney (19). + All exhibits have been filed electronically. (1) Response is incorporated by reference to Registrant's Initial Registration Statement on Form N-1A. (File Nos. 2-94560 and 811-4154). (2) Response is incorporated by reference to Registrant's Pre-Effective Amendment No. 1 on Form N-1A (File Nos. 2-94560 and 811-4154). (5) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 11 filed on July 30, 1990 on Form N-1A (File Nos. 2-94560 and 811-4154). (11) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 20 filed on August 26, 1992 on Form N-1A (File Nos. 2- 94560 and 811-4154). (14) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 28 filed on April 15, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (15) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 29 filed on April 30, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (16) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 31 filed on June 14, 1993 on Form N-1A (File Nos. 2-94560 and 811-4154). (17) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 32 filed on November 2, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (18) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 33 filed on December 29, 1993 on Form N-1A (File Nos. 2- 94560 and 811-4154). (19) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 35 filed on February 25, 1994 on Form N-1A (File Nos. 2- 94560 and 811-4154). (20) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 36 filed on June 28, 1994 on Form N-1A (File Nos. 2-94560 and 811-4154). (21) Response is incorporated by reference to Registrant's Post-Effective Amendment No. 38 filed on December 30, 1994 on Form N-1A (File Nos. 2- 94560 and 811-4154). Item 25. Persons Controlled by or Under Common Control with Registrant: None Item 26. Number of Holders of Securities: Number of Record Holders Title of Class as of February 6, 1995 Shares of beneficial interest (no par value) First Union Value Portfolio a) Y Shares 78 b) Class A Investment Shares 16,542 c) Class B Investment Shares 11,172 d) Class C Investment Shares 61 First Union Fixed Income Portfolio a) Y Shares 5 b) Class A Investment Shares 1,539 c) Class B Investment Shares 1,090 d) Class C Investment Shares 22 First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio) a) Y Shares 11 b) Class A Investment Shares 1,797 c) Class B Investment Shares 975 First Union Tax Free Money Market Portfolio a) Y Shares 4 b) Class A Investment Shares 1,389 First Union Money Market Portfolio a) Y Shares 5 b) Class A Investment Shares 6,614 c) Class B Investment Shares 329 First Union Treasury Money Market Portfolio a) Y Shares 4 b) Class A Investment Shares 1,854 First Union Balanced Portfolio a) Y Shares 5 b) Class A Investment Shares 3,351 c) Class B Investment Shares 8,479 d) Class C Investment Shares 26 First Union Managed Bond Portfolio a) Y Shares 53 First Union North Carolina Municipal Bond Portfolio a) Y Shares 14 b) Class A Investment Shares 328 c) Class B Investment Shares 1,662 First Union U.S. Government Portfolio a) Y Shares 4 b) Class A Investment Shares 1,126 c) Class B Investment Shares 8,498 d) Class C Investment Shares 15 First Union Florida Municipal Bond Portfolio a) Y Shares 16 b) Class A Investment Shares 250 c) Class B Investment Shares 736 First Union Georgia Municipal Bond Portfolio a) Y Shares 5 b) Class A Investment Shares 80 c) Class B Investment Shares 334 First Union Virginia Municipal Bond Portfolio a) Y Shares 8 b) Class A Investment Shares 68 c) Class B Investment Shares 168 First Union Utility Portfolio a) Y Shares 5 b) Class A Investment Shares 610 c) Class B Investment Shares 2,740 d) Class C Investment Shares 16 First Union South Carolina Municipal Bond Portfolio a) Y Shares 6 b) Class A Investment Shares 15 c) Class B Investment Shares 100 First Union Emerging Markets Growth Portfolio a) Y Shares 4 b) Class A Investment Shares 244 c) Class B Investment Shares 333 d) Class C Investment Shares 12 First Union International Equity Portfolio a) Y Shares 4 b) Class A Investment Shares 733 c) Class B Investment Shares 1,197 d) Class C Investment Shares 38 Item 27. Indemnification: (1.) (1.) Response is incorporated by reference to Registrant's Post- Effective Amendment No. 35 filed on February 25, 1994 on Form N- 1A (File Nos. 2-94560 and 811-4154). Item 28. Business and Other Connections of Investment Adviser: (a) For a description of the other business of the investment adviser, see the section entitled "Management of First Union Funds-Investment Adviser" in Part A. The Trustees and principal executive officers of the Fund's Investment Adviser, and the Directors of the Fund's Manager, are set forth in the following tables: FIRST UNION NATIONAL BANK OF NORTH CAROLINA BOARD OF DIRECTORS Ben Mayo Boddie Raymond A. Bryan, Jr. Chairman & CEO Chairman & CEO Boddie-Noell Enterprises, Inc. T.A. Loving Company P.O. Box 1908 P.O. Drawer 919 Rocky Mount, NC 27802 Goldsboro, NC 27530 John F.A.V. Cecil John W. Copeland President President Biltmore Dairy Farms, Inc. Ruddick Corporation P.O. Box 5355 2000 Two First Union Center Asheville, NC 28813 Charlotte, NC 28282 John Crosland, Jr. J. William Disher Chairman of the Board Chairman & President The Crosland Group, Inc. Lance Incorporated 135 Scaleybark Road P.O. Box 32368 Charlotte, NC 28209 Charlotte, NC 28232 Frank H. Dunn Malcolm E. Everett, III Chairman and CEO President First Union National Bank First Union National Bank of North Carolina of North Carolina One First Union Center 310 S. Tryon Street Charlotte, NC 28288-0006 Charlotte, NC 28288-0156 James F. Goodmon Shelton Gorelick President & Chief President Executive Officer SGIC, Inc. Capitol Broadcasting 741 Kenilworth Ave., Suite 200 Company, Inc. Charlotte, NC 28204 2619 Western Blvd. Raleigh, NC 27605 Charles L. Grace James E. S. Hynes President Chairman Cummins Atlantic, Inc. Hynes Sales Company, Inc. P.O. Box 240729 P.O. Box 220948 Charlotte, NC 28224-0729 Charlotte, NC 28222 Daniel W. Mathis Earl N. Phillips, Jr. Vice Chairman President First Union National Bank First Factors Corporation of North Carolina P.O. Box 2730 One First Union Center High Point, NC 27261 Charlotte, NC 28288-0009 J. Gregory Poole, Jr. John P. Rostan, III Chairman & President Senior Vice President Gregory Poole Equipment Company Waldensian Bakeries, Inc. P.O. Box 469 P.O. Box 220 Raleigh, NC 27602 Valdese, NC 28690 Nelson Schwab, III Charles M. Shelton, Sr. Chairman & CEO Chairman & CEO Paramount Parks The Shelton Companies, Inc 8720 Red Oak Boulevard, Suite 315 3600 One First Union Center Charlotte, NC 28217 Charlotte, NC 28202 George Shinn Harley F. Shuford, Jr. Owner and Chairman President and CEO Shinn Enterprises, Inc. Shuford Industries One Hive Drive P.O. Box 608 Charlotte, NC 28217 Hickory, NC 28603 FIRST UNION NATIONAL BANK OF NORTH CAROLINA EXECUTIVE OFFICERS James Maynor, President, First Union Mortgage Corporation; Austin A. Adams, Executive Vice President; Howard L. Arthur, Senior Vice President; Robert T. Atwood, Executive Vice President and Chief Financial Officer; Marion A. Cowell, Jr., Executive Vice President, Secretary and General Counsel; Edward E. Crutchfield, Jr., Chairman, CEO, First Union Corporation; Frank H. Dunn, Jr., Chairman and CEO; Malcolm E. Everett, III, President; John R. Georgius, President, First Union Corporation; James Hatch, Senior Vice President and Corporate Controller; Don R. Johnson, Executive Vice President; Mark Mahoney, Senior Vice President; Barbara K. Massa, Senior Vice President; Daniel W. Mathis, Vice Chairman; H. Burt Melton, Executive Vice President; Malcolm T. Murray, Jr., Executive Vice President; Alvin T. Sale, Executive Vice President; Louis A. Schmitt, Jr., Executive Vice President; Ken Stancliff, Senior Vice President and Corporate Treasurer; Richard K. Wagoner, Executive Vice President and General Fund Officer. All of the Executive Officers are located at the following address: First Union National Bank of North Carolina, One First Union Center, Charlotte, NC 28288. (b) For a description of the other business of the sub-adviser to First Union Emerging Markets Growth Portfolio ("Emerging Makrets Growth Fund"), see the section entitled "Management of First Union Funds-Sub-Advisers-Emerging Markets Growth Fund" in Part A. The Principals and principal executive officers of the Emerging Markets Growth Fund's Sub-Adviser, and the Members of the Advisory Board of the Sub-Adviser, are set forth in the following tables. Unless otherwise noted, the position listed under Other Stubstantial Business, Profession, Vocation or Employment is with Marvin & Palmer Associates, Inc.: MARVIN & PALMER ASSOCIATES, INC. Other Substantial Position With Business, Profession, Name the Sub-Adviser Vocation or Employment David F. Marvin, CFA Chairman Portfolio Manager- Americas & Currency Stanley Palmer, CFA President Portfolio Manager- Non-U.S. Karen T. Buckley Senior Vice President and Chief Financial Officer Jon A. Stiklorius Senior Vice President Eugene J. Mulvaney Senior Vice President Terry B. Mason Vice President Portfolio Manager- Non-U.S. Jay F. Middleton Vice President Portfolio Manager- Americas Todd D. Marvin Vice President Portfolio Manager- Non-U.S. William Nord Vice President Robert P. Sanna Vice President David L. Schaen Vice President Raymond J. Deschenes Vice President ADVISORY BOARD MEMBERS Irving S. Shapiro Paul Craig Roberts William C. Lickle The Hon. Charles J. Pilliod, Jr. Charles L. Brown Dr.-Ing. Klaus G. Lederer Alexander F. Giacco The Rt. Hon. Lord Moore, P.C. (c) For a description of the other business of the sub-adviser to First Union International Equity Portfolio ("International Equity Fund"), see the section entitled "Management of First Union Funds-Sub-Advisers-International Equity Fund" in Part A. The Trustees and principal executive officers of the International Equity Fund's Sub-Adviser, and the Directors and officers of the Fund's Sub-Adviser, are set forth in the following tables. Unless otherwise noted, the position listed under Other Substantial Business, Profession, Vocation or Employment is with Boston International Advisors, Inc.: BOSTON INTERNATIONAL ADVISORS, INC. Other Substantial Position With Business, Profession, Name the Sub-Adviser Vocation or Employment Lyle H. Davis President and Managing Director Robert E. Denneen, Jr. Vice President Portfolio Manager Dennis J. Fogarty Vice President Research Associate Maureen A. Ghublikian Managing Director Norman H. Meltz Vice President & Managing Director Patricia A. Thompson Vice President & Treasurer David A. Umstead Managing Director BOARD OF DIRECTORS George A. Chamberlain, III Philip A. Cooper Lyle H. Davis Norman H. Meltz David A. Umstead Item 29. Principal Underwriters: (a) Federated Securities Corp., the Distributor for shares of the Registrant, also acts as principal underwriter for the following open-end investment companies: Alexander Hamilton Funds; American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Fund; Automated Government Money Fund; BayFunds; The Biltmore Funds; The Biltmore Municipal Funds; California Municipal Cash Fund; Cash Fund Series, Inc.; Cash Fund Series II; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Fund; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Fund; Federated Government Fund; Federated Growth Fund; Federated High Yield Fund; Federated Income Securities Fund; Federated Income Fund; Federated Index Fund; Federated Institutional Fund; Federated Intermediate Government Fund; Federated Master Fund; Federated Municipal Fund; Federated Short-Intermediate Government Fund; Federated Short-Term U.S. Government Fund; Federated Stock Fund; Federated Tax-Free Fund; Federated U.S. Government Bond Fund; First Priority Funds; First Union Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fountain Square Funds; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Fund; Independence One Mutual Funds; Insight Institutional Series, Inc.; Insurance Management Series; Intermediate Municipal Fund; International Series Inc.; Investment Series Funds, Inc.; Investment Series Fund; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Fund; Liberty Utility Fund, Inc.; Liquid Cash Fund; Managed Series Fund; Marshall Funds, Inc.; Money Market Management, Inc.; The Medalist Funds; Money Market Obligations Fund; Money Market Fund; The Monitor Funds; Municipal Securities Income Fund; New York Municipal Cash Fund; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; Portage Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Fund; SouthFund Vulcan Funds; Star Funds; The Starburst Funds; The Starburst Funds II; Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Fund; Tax-Free Instruments Fund; Tower Mutual Funds; Trademark Funds; Fund for Financial Institutions; Fund for Government Cash Reserves; Fund for Short-Term U.S. Government Securities; Fund for U.S. Treasury Obligations; Vision Fiduciary Funds, Inc.; Vision Group of Funds, Inc.; and World Investment Series, Inc. Federated Securities Corp. also acts as principal underwriter for the following closed-end investment company: Liberty Term Fund, Inc.- 1999. (b) (1) (2) (3) Name and Principal Positions and Offices Positions and Offices Business Address With Underwriter With Registrant Richard B. Fisher Director, Chairman, Chief Federated Investors Tower Executive Officer, Chief Pittsburgh, PA 15222-3779 Operating Officer, and Asst. Treasurer, Federated Securities Corp. Edward C. Gonzales Director, Executive Vice President, Federated Investors Tower President, and Treasurer, Treasurer, Pittsburgh, PA 15222-3779 Federated Securities and Trustee Corp. John W. McGonigle Director, Executive Vice Federated Investors Tower President, and Assistant Pittsburgh, PA 15222-3779 Secretary, Federated Securities Corp. John B. Fisher President-Institutional Sales, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 James F. Getz President-Broker/Dealer, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Mark R. Gensheimer Executive Vice President of -- Federated Investors Tower Bank/Trust Pittsburgh, PA 15222-3779 Federated Securities Corp. Mark W. Bloss Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Theodore Fadool, Jr. Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Bryant R. Fisher Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Christopher T. Fives Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 James S. Hamilton Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 James M. Heaton Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 H. Joseph Kennedy Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Keith Nixon Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Solon A. Person, IV Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Timothy C. Pillion Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Thomas E. Territ Senior Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 John B. Bohnet Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Richard W. Boyd Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Jane E. Broeren-Lambesis Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Mary J. Combs Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 R. Edmond Connell, Jr. Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Kevin J. Crenny Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Daniel T. Culbertson Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Laura M. Deger Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Jill Ehrenfeld Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Joseph L. Epstein Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Mark D. Fisher Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Michael D. Fitzgerald Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Joseph D. Gibbons Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 David C. Glabicki Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Craig S. Gonzales Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Richard C. Gonzales Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Scott A. Hutton Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 William J. Kerns Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 William E. Kugler Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Dennis M. Laffey Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Stephen A. LaVersa Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Francis J. Matten, Jr. Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Mark J. Miehl Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Richard C. Mihm Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 J. Michael Miller Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 R. Jeffrey Niss Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Michael P. O'Brien Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Robert D. Oehlschlager Vice President, Federated Investors Tower Federated Securities Corp. -- Pittsburgh, PA 15222-3779 Robert F. Phillips Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Eugene B. Reed Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Paul V. Riordan Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Charles A. Robison Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 John C. Shelar, Jr. Vice President, Federated Investors Tower Federated Securities Corp. -- Pittsburgh, PA 15222-3779 David W. Spears Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Jeffrey A. Stewart Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Jamie M. Teschner Vice President, Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 William C. Tustin Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Paul A. Uhlman Vice President, Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Richard B. Watts Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Michael P. Wolff Vice President, Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Philip C. Hetzel Assistant Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Charlene H. Jennings Assistant Vice President, Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 Ernest L. Linane Assistant Vice President, -- Federated Investors Tower Federated Securities Corp. Pittsburgh, PA 15222-3779 S. Elliott Cohan Secretary, Assistant Federated Investors Tower Federated Securities Corp. Secretary Pittsburgh, PA 15222-3779 (c) Not applicable. Item 30. Location of Accounts and Records: All accounts and records required to be maintained by Section 31(a) of the Investment Company Act of 1940 and Rules 31a-1 through 31a-3 promulgated thereunder are maintained at one of the following locations: Registrant Federated Investors Tower Federated Services Company Pittsburgh, PA 15222-3779 ("Transfer Agent and Dividend Disbursing Agent") Federated Administrative Services ("Administrator") First Union National Bank of North Carolina One First Union Center ("Adviser") 301 S. College Street Charlotte, North Carolina 28288 State Street Bank and Fund Company P.O. Box 8609 ("Custodian") Boston, MA 02266-8609 Item 31. Management Services: Not applicable. Item 32. Undertakings: Registrant hereby undertakes to comply with the provisions of Section 16(c) of the 1940 Act with respect to the removal of Trustees and the calling of special shareholder meetings by shareholders. Registrant hereby undertakes to furnish each person to whom a prospectus is delivered with a copy of the Registrant's latest annual report to shareholders, upon request and without charge. ____________________ SIGNATURES Pursuant to the requirements of the Securities Act of 1933 and the Investment Company Act of 1940, the Registrant, FIRST UNION FUNDS, certifies that it meets all of the requirements for effectiveness of this Amendment to its Registration Statement pursuant to Rule 485 (b) under the Securities Act of 1933 and has duly caused this Amendment to its Registration Statement to be signed on its behalf by the undersigned, thereto duly authorized, in the City of Pittsburgh and Commonwealth of Pennsylvania, on the 28th day of February, 1995 FIRST UNION FUNDS BY: /s/Mark A. Sheehan Mark A. Sheehan, Assistant Secretary Attorney in Fact for John F. Donahue February 28, 1995 Pursuant to the requirements of the Securities Act of 1933, this Amendment to its Registration Statement has been signed below by the following person in the capacity and on the date indicated: NAME TITLE DATE By: /s/Mark A. Sheehan Mark A. Sheehan Attorney In Fact February 28, 1995 ASSISTANT SECRETARY For the Persons Listed Below NAME TITLE James S. Howell* Chairman and Trustee (Chief Executive Officer) Edward C. Gonzales* President, Treasurer and Trustee (Principal Financial and Accounting Officer) Gerald M. McDonnell* Trustee Thomas L. McVerry* Trustee William Walt Pettit* Trustee Russell A. Salton, III, M.D.* Trustee Michael S. Scofield* Trustee * By Power of Attorney EX-99.AUDITOR 2 Exhibit 11 under Form N-1A Exhibit 23 under Item 601/Reg SK INDEPENDENT AUDITORS' CONSENT The Board of Trustees First Union Funds: With respect to the Prospectuses and Statements of Additional Information included in this Post Effective Amendment No. 39 to the Registration Statement on Form N-1A of First Union Funds, we consent to the use of our reports, dated February 13, 1995, included herein and to the references to our Firm under the headings "Financial Highlights" and "Management of First Union Funds" in Part A of the Registration Statement. o First Union Money Market Portfolio; o First Union Tax Free Money Market Portfolio; o First Union Treasury Money Market Portfolio; o First Union Fixed Income Portfolio; o First Union Managed Bond Portfolio' o First Union U.S. Government Portfolio; o First Union Balanced Portfolio; o First Union Unity Portfolio; o First Union Value Portfolio; o First Union Emerging Markets Growth Portfolio; o First Union International Equity Portfolio; o First Union Florida Municipal Bond Portfolio; o First Union Georgia Municipal Bond Portfolio; o First Union North Carolina Municipal Bond Portfolio; o First Union South Carolina Municipal Bond Portfolio; o First Union Virginia Municipal Bond Portfolio; and o First Union High Grade Tax Free Portfolio. By: KPMG Peat Marwick LLP KPMG Peat Marwick LLP Pittsburgh, Pennsylvania February 24, 1995 EX-99.SCHEDULE 3
Exhibit 16 (i) under Form N-1A Exhibit 99 under Item 601/Reg. Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Emerging - A Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/5/94 100.000 0.000000000 0.00000 $10.00 100.000 $10.00 $1,000.00 12/31/94 100.000 0.000000000 0.00000 $8.17 100.000 $8.17 $817.00 $1,000 (1+T) = End Value T = -18.30%
EX-99.SCHEDULE 4
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Emerging - B Price/ Share= $10.50 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/5/94 95.238 0.000000000 0.00000 $10.00 95.238 $10.00 $952.38 12/31/94 95.238 0.000000000 0.00000 $8.17 95.238 $8.17 $778.10 $1,000 (1+T) = End Value T = -22.19%
EX-99.SCHEDULE 5
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Emerging - C Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/5/94 100.000 0.000000000 0.00000 $10.00 100.000 $10.00 $1,000.00 12/31/94 100.000 0.000000000 0.00000 $8.16 100.000 $7.75 $775.00 $1,000 (1+T) = End Value T = -22.50%
EX-99.SCHEDULE 6
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Emerging - D Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/5/94 100.000 0.000000000 0.00000 $10.00 100.000 $10.00 $1,000.00 12/31/94 100.000 0.000000000 0.00000 $8.16 100.000 $8.08 $808.00 $1,000 (1+T) = End Value T = -19.20%
EX-99.SCHEDULE 7
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Int'l Eq - A Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.08 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/2/94 100.000 0.000000000 0.00000 $10.08 100.000 $10.08 $1,008.00 12/21/94 100.000 0.006000000 0.00140 $9.35 100.079 $9.35 $935.74 12/31/94 100.079 0.000000000 0.00000 $9.49 100.079 $9.49 $949.75 $1,000 (1+T) = End Value T = -5.02%
EX-99.SCHEDULE 8
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Int'l Eq - B Price/ Share= $10.50 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/1/94 95.238 0.000000000 0.00000 $10.00 95.238 $10.00 $952.38 12/21/94 95.238 0.001000000 0.00140 $9.35 95.263 $9.35 $890.70 12/31/94 95.263 0.000000000 0.00000 $9.49 95.263 $9.49 $904.04 $1,000 (1+T) = End Value T = -9.60%
EX-99.SCHEDULE 9
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Int'l Eq - C Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/1/94 100.000 0.000000000 0.00000 $10.00 100.000 $10.00 $1,000.00 12/21/94 100.000 0.000000000 0.00140 $9.35 100.015 $9.35 $935.14 12/31/94 100.015 0.000000000 0.00000 $9.48 100.015 $9.01 $901.13 $1,000 (1+T) = End Value T = -9.89%
EX-99.SCHEDULE 10
Schedule for Computation Initial of Fund Performance Data Invest of: $1,000 Offering First Un. Int'l Eq - D Price/ Share= $10.00 Return Since Inception ending 12/31/94 NAV= $10.00 FYE: December 31 Begin Capital Reinvest Ending Total DECLARED: ANNUALLY Reinvest Period Dividend Gain Price Period Ending Invest PAID: ANNUALLY Dates Shares /Share /Share /Share Shares Price Value 9/1/94 100.000 0.000000000 0.00000 $10.00 100.000 $10.00 $1,000.00 12/21/94 100.000 0.000000000 0.00140 $9.35 100.015 $9.35 $935.14 12/31/94 100.015 0.000000000 0.00000 $9.48 100.015 $9.39 $939.14 $1,000 (1+T) = End Value T = -6.09%
EX-27.FINANDATASCHED 11
6 1 First Union Balanced Portfolio Class A 12-MOS Dec-31-1994 Dec-31-1994 906,344,902 923,650,524 7,421,951 28,949 0 931,101,424 3,397,140 0 7,790,923 11,188,063 0 902,497,045 3,671,118 2,901,446 495,614 0 (384,920) 0 17,305,622 41,009,712 16,691,618 25,575,851 0 6,774,853 35,492,616 15,321,171 (72,298,630) (21,484,843) 0 1,519,114 699,327 0 1,428,629 845,164 186,207 59,259,731 340,833 (456) 0 0 4,621,512 0 6,774,853 922,366,159 12.070 0.430 (0.710) 0.430 0.190 0.000 11.170 89 0 0.000
EX-27.FINANDATASCHED 12
6 2 First Union Balanced Portfolio Class B 12-MOS Dec-31-1994 Dec-31-1994 906,344,902 923,650,524 7,421,951 28,949 0 931,101,424 3,397,140 0 7,790,923 11,188,063 0 902,497,045 8,947,916 5,420,479 495,614 0 (384,920) 0 17,305,622 100,051,739 16,691,618 25,575,851 0 6,774,853 35,492,616 15,321,171 (72,298,630) (21,484,843) 0 2,795,862 1,691,363 0 4,255,156 1,102,578 374,859 59,259,731 340,833 (456) 0 0 4,621,512 0 6,774,853 922,366,159 12.080 0.360 (0.710) 0.360 0.190 0.000 11.180 148 0 0.000
EX-27.FINANDATASCHED 13
6 3 First Union Balanced Portfolio Class C 12-MOS Dec-31-1994 Dec-31-1994 906,344,902 923,650,524 7,421,951 28,949 0 931,101,424 3,397,140 0 7,790,923 11,188,063 0 902,497,045 17,479 0 495,614 0 (384,920) 0 17,305,622 195,200 16,691,618 25,575,851 0 6,774,853 35,492,616 15,321,171 (72,298,630) (21,484,843) 0 1,794 3,132 0 17,041 0 438 59,259,731 340,833 (456) 0 0 4,621,512 0 6,774,853 922,366,159 12.000 0.180 (0.610) 0.210 0.190 0.000 11.170 164 0 0.000
EX-27.FINANDATASCHED 14
6 4 First Union Balanced Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 906,344,902 923,650,524 7,421,951 28,949 0 931,101,424 3,397,140 0 7,790,923 11,188,063 0 902,497,045 69,701,984 62,962,620 495,614 0 (384,920) 0 17,305,622 778,656,710 16,691,618 25,575,851 0 6,774,853 35,492,616 15,321,171 (72,298,630) (21,484,843) 0 31,021,065 13,311,813 0 20,165,185 17,187,695 3,761,875 59,259,731 340,833 (456) 0 0 4,621,512 0 6,774,853 922,366,159 12.070 0.460 (0.710) 0.460 0.190 0.000 11.170 64 0 0.000
EX-27.FINANDATASCHED 15
6 5 First Union Emerging Markets Growth Portfolio Class A Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 9,824,308 8,355,931 118,855 919 0 8,475,705 0 0 52,252 52,252 0 9,991,162 106,190 0 3,717 0 (103,062) 0 (1,468,364) 867,049 20,058 23,839 0 40,180 3,717 (103,062) (1,468,364) (1,567,709) 0 0 0 0 107,331 1,141 0 8,423,453 0 0 0 0 35,047 0 91,117 7,222,755 10.000 0.000 (1.830) 0.000 0.000 0.000 8.170 178 0 0.000
EX-27.FINANDATASCHED 16
6 6 First Union Emerging Markets Growth Portfolio Class B Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 9,824,308 8,355,931 118,855 919 0 8,475,705 0 0 52,252 52,252 0 9,991,162 194,720 0 3,717 0 (103,062) 0 (1,468,364) 1,589,047 20,058 23,839 0 40,180 3,717 (103,062) (1,468,364) (1,567,709) 0 0 0 0 202,997 8,277 0 8,423,453 0 0 0 0 35,047 0 91,117 7,222,755 10.000 (0.020) (1.820) 0.000 0.000 0.000 8.160 253 0 0.000
EX-27.FINANDATASCHED 17
6 7 First Union Emerging Markets Growth Portfolio Class C Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 9,824,308 8,355,931 118,855 919 0 8,475,705 0 0 52,252 52,252 0 9,991,162 10,933 0 3,717 0 (103,062) 0 (1,468,364) 89,236 20,058 23,839 0 40,180 3,717 (103,062) (1,468,364) (1,567,709) 0 0 0 0 10,933 0 0 8,423,453 0 0 0 0 35,047 0 91,117 7,222,755 10.000 (0.020) (1.820) 0.000 0.000 0.000 8.160 253 0 0.000
EX-27.FINANDATASCHED 18
6 8 First Union Emerging Markets Growth Portfolio Y Shares 4-MOS Dec-31-1994 Dec-31-1994 9,824,308 8,355,931 118,855 919 0 8,475,705 0 0 52,252 52,252 0 9,991,162 719,827 0 3,717 0 (103,062) 0 (1,468,364) 5,878,121 20,058 23,839 0 40,180 3,717 (103,062) (1,468,364) (1,567,709) 0 0 0 0 724,945 5,118 0 8,423,453 0 0 0 0 35,047 0 91,117 7,222,755 10.000 0.010 (1.840) 0.000 0.000 0.000 8.170 153 0 0.000
EX-27.FINANDATASCHED 19
6 9 First Union Fixed Income Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 403,108,910 378,307,627 5,596,256 528 0 383,904,411 0 0 1,615,293 1,615,293 0 412,844,774 2,009,397 2,193,753 219,997 0 (5,974,370) 0 (24,801,283) 19,126,757 0 29,194,972 0 2,781,015 26,413,957 (6,020,616) (31,162,934) (10,769,593) 0 1,390,210 1,063 0 496,948 797,380 116,076 (25,897,070) 43,154 65,625 0 0 2,022,773 0 2,781,015 404,221,272 10.420 0.650 (0.910) 0.640 0.000 0.000 9.520 75 0 0.000
EX-27.FINANDATASCHED 20
6 10 First Union Fixed Income Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 403,108,910 378,307,627 5,596,256 528 0 383,904,411 0 0 1,615,293 1,615,293 0 412,844,774 1,846,547 849,941 219,997 0 (5,974,370) 0 (24,801,283) 17,624,970 0 29,194,972 0 2,781,015 26,413,957 (6,020,616) (31,162,934) (10,769,593) 0 813,680 679 0 1,377,400 439,397 58,604 (25,897,070) 43,154 65,625 0 0 2,022,773 0 2,781,015 404,221,272 10.440 0.580 (0.920) 0.560 0.000 0.000 9.540 150 0 0.000
EX-27.FINANDATASCHED 21
6 11 First Union Fixed Income Portfolio Class C Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 403,108,910 378,307,627 5,596,256 528 0 383,904,411 0 0 1,615,293 1,615,293 0 412,844,774 53,685 0 219,997 0 (5,974,370) 0 (24,801,283) 512,570 0 29,194,972 0 2,781,015 26,413,957 (6,020,616) (31,162,934) (10,769,593) 0 6,924 0 0 54,641 1,243 287 (25,897,070) 43,154 65,625 0 0 2,022,773 0 2,781,015 404,221,272 9.850 0.180 (0.300) 0.180 0.000 0.000 9.550 165 0 0.000
EX-27.FINANDATASCHED 22
6 12 First Union Fixed Income Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 403,108,910 378,307,627 5,596,256 528 0 383,904,411 0 0 1,615,293 1,615,293 0 412,844,774 36,238,495 36,106,822 219,997 0 (5,974,370) 0 (24,801,283) 345,024,821 0 29,194,972 0 2,781,015 26,413,957 (6,020,616) (31,162,934) (10,769,593) 0 24,026,300 17,637 0 10,329,803 12,477,326 2,279,195 (25,897,070) 43,154 65,625 0 0 2,022,773 0 2,781,015 404,221,272 10.430 0.650 (0.910) 0.650 0.000 0.000 9.520 65 0 0.000
EX-27.FINANDATASCHED 23
6 13 First Union Florida Municipal Bond Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 36,767,689 34,121,872 2,806,269 250,529 0 37,178,670 1,204,682 0 764,706 1,969,388 0 39,922,184 974,131 784,075 0 0 (2,067,085) 0 (2,645,817) 8,689,087 0 2,002,836 0 355,461 1,647,375 (2,059,403) (3,012,525) (3,424,553) 0 478,019 0 0 769,573 606,508 26,991 8,715,800 0 (7,682) 0 0 171,732 0 617,411 34,621,310 10.340 0.490 (1.420) 0.490 0.000 0.000 8.920 64 0 0.000
EX-27.FINANDATASCHED 24
6 14 First Union Florida Municipal Bond Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 36,767,689 34,121,872 2,806,269 250,529 0 37,178,670 1,204,682 0 764,706 1,969,388 0 39,922,184 2,775,663 1,777,823 0 0 (2,067,085) 0 (2,645,817) 24,756,282 0 2,002,836 0 355,461 1,647,375 (2,059,403) (3,012,525) (3,424,553) 0 1,098,233 0 0 1,596,854 661,049 62,035 8,715,800 0 (7,682) 0 0 171,732 0 617,411 34,621,310 10.340 0.430 (1.420) 0.430 0.000 0.000 8.920 122 0 0.000
EX-27.FINANDATASCHED 25
6 15 First Union Florida Municipal Bond Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 36,767,689 34,121,872 2,806,269 250,529 0 37,178,670 1,204,682 0 764,706 1,969,388 0 39,922,184 197,806 0 0 0 (2,067,085) 0 (2,645,817) 1,763,913 0 2,002,836 0 355,461 1,647,375 (2,059,403) (3,012,525) (3,424,553) 0 71,123 0 0 287,077 90,201 930 8,715,800 0 (7,682) 0 0 171,732 0 617,411 34,621,310 9.990 0.420 (1.070) 0.420 0.000 0.000 8.920 39 0 0.000
EX-27.FINANDATASCHED 26
6 16 First Union Georgia Municipal Bond Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 8,195,670 8,044,749 533,096 81,438 0 8,659,283 0 0 76,672 76,672 0 9,620,985 158,671 80,206 0 0 (887,457) 0 (150,917) 1,386,598 0 425,227 0 74,397 350,830 (887,457) (185,649) (722,276) 0 64,118 0 0 100,861 27,500 5,104 4,073,637 0 0 0 0 36,674 0 300,817 7,482,921 10.190 0.480 (1.450) 0.480 0.000 0.000 8.740 53 0 0.000
EX-27.FINANDATASCHED 27
6 17 First Union Georgia Municipal Bond Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 8,195,670 8,044,749 533,096 81,438 0 8,659,283 0 0 76,672 76,672 0 9,620,985 790,862 362,215 0 0 (887,457) 0 (150,917) 6,911,706 0 425,227 0 74,397 350,830 (887,457) (185,649) (722,276) 0 278,937 0 0 586,440 180,297 22,504 4,073,637 0 0 0 0 36,674 0 300,817 7,482,921 10.190 0.430 (1.450) 0.430 0.000 0.000 8.740 113 0 0.000
EX-27.FINANDATASCHED 28
6 18 First Union Georgia Municipal Bond Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 8,195,670 8,044,749 533,096 81,438 0 8,659,283 0 0 76,672 76,672 0 9,620,985 32,533 0 0 0 (887,457) 0 (150,917) 284,307 0 425,227 0 74,397 350,830 (887,457) (185,649) (722,276) 0 7,775 0 0 32,285 41 289 4,073,637 0 0 0 0 36,674 0 300,817 7,482,921 9.830 0.420 (1.090) 0.420 0.000 0.000 8.740 31 0 0.000
EX-27.FINANDATASCHED 29
6 19 First Union High Grade Tax Free Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 96,691,204 92,714,663 3,782,801 9,832 0 96,507,296 1,440,086 0 637,530 2,077,616 0 99,317,449 5,888,392 9,085,725 0 0 (911,228) 0 (3,976,541) 57,676,448 0 7,261,577 0 1,421,839 5,839,738 (912,236) (15,618,845) (10,691,343) 0 3,977,507 0 0 555,825 3,992,062 238,904 (47,952,744) 0 1,008 0 0 599,854 0 1,437,929 120,153,198 11.160 0.520 (1.370) 0.520 0.000 0.000 9.790 101 0 0.000
EX-27.FINANDATASCHED 30
6 20 First Union High Grade Tax Free Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 96,691,204 92,714,663 3,782,801 9,832 0 96,507,296 1,440,086 0 637,530 2,077,616 0 99,317,449 3,311,416 3,678,178 0 0 (911,228) 0 (3,976,541) 32,434,792 0 7,261,577 0 1,421,839 5,839,738 (912,236) (15,618,845) (10,691,343) 0 1,722,197 0 0 619,543 1,088,820 102,516 (47,952,744) 0 1,008 0 0 599,854 0 1,437,929 120,153,198 11.160 0.460 (1.370) 0.460 0.000 0.000 9.790 158 0 0.000
EX-27.FINANDATASCHED 31
6 21 First Union High Grade Tax Free Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 96,691,204 92,714,663 3,782,801 9,832 0 96,507,296 1,440,086 0 637,530 2,077,616 0 99,317,449 440,914 0 0 0 (911,228) 0 (3,976,541) 4,318,440 0 7,261,577 0 1,421,839 5,839,738 (912,236) (15,618,845) (10,691,343) 0 140,034 0 0 532,658 93,031 1,287 (47,952,744) 0 1,008 0 0 599,854 0 1,437,929 120,153,198 10.920 0.460 (1.130) 0.460 0.000 0.000 9.790 76 0 0.000
EX-27.FINANDATASCHED 32
6 22 First Union International Equity Portfolio Class A Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 33,619,561 32,529,132 1,454,068 513,899 0 34,497,099 1,278,665 0 1,078,907 2,357,572 0 33,215,142 267,930 0 50,645 0 (32,131) 0 (1,094,129) 2,544,906 133,535 22,775 0 91,351 64,959 (27,654) (1,094,129) (1,056,824) 0 259 363 0 271,932 4,068 65 32,139,527 0 0 0 0 60,885 0 152,717 22,659,955 10.000 0.020 (0.520) 0.000 0.000 0.000 9.500 126 0 0.000
EX-27.FINANDATASCHED 33
6 23 First Union International Equity Portfolio Class B Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 33,619,561 32,529,132 1,454,068 513,899 0 34,497,099 1,278,665 0 1,078,907 2,357,572 0 33,215,142 589,954 0 50,645 0 (32,131) 0 (1,094,129) 5,602,374 133,535 22,775 0 91,351 64,959 (27,654) (1,094,129) (1,056,824) 0 0 811 0 601,778 11,910 86 32,139,527 0 0 0 0 60,885 0 152,717 22,659,955 10.000 0.000 (0.500) 0.000 0.000 0.000 9.500 202 0 0.000
EX-27.FINANDATASCHED 34
6 24 First Union International Equity Portfolio Class C Investment Shares 4-MOS Dec-31-1994 Dec-31-1994 33,619,561 32,529,132 1,454,068 513,899 0 34,497,099 1,278,665 0 1,078,907 2,357,572 0 33,215,142 17,132 0 50,645 0 (32,131) 0 (1,094,129) 162,663 133,535 22,775 0 91,351 64,959 (27,654) (1,094,129) (1,056,824) 0 0 24 0 17,281 151 3 32,139,527 0 0 0 0 60,885 0 152,717 22,659,955 10.000 0.030 (0.540) 0.000 0.000 0.000 9.490 201 0 0.000
EX-27.FINANDATASCHED 35
6 25 First Union International Equity Portfolio Y Shares 4-MOS Dec-31-1994 Dec-31-1994 33,619,561 32,529,132 1,454,068 513,899 0 34,497,099 1,278,665 0 1,078,907 2,357,572 0 33,215,142 2,509,397 0 50,645 0 (32,131) 0 (1,094,129) 23,829,584 133,535 22,775 0 91,351 64,959 (27,654) (1,094,129) (1,056,824) 0 14,055 3,279 0 2,526,593 17,935 739 32,139,527 0 0 0 0 60,885 0 152,717 22,659,955 10.000 0.020 (0.510) 0.010 0.000 0.000 9.500 106 0 0.000
EX-27.FINANDATASCHED 36
6 26 First Union Managed Bond Portfolio 12-MOS Dec-31-1994 Dec-31-1994 94,045,952 88,641,814 1,686,686 9,732 0 90,338,232 0 0 19,977 19,977 0 97,083,445 9,656,565 10,423,512 86,211 0 (1,447,263) 0 (5,404,138) 90,318,255 0 7,723,172 0 731,145 6,992,027 (1,440,454) (10,390,618) (4,839,045) 0 6,989,831 0 0 2,292,625 3,747,274 687,702 (18,748,815) 84,015 265,646 0 0 523,270 0 741,832 104,607,670 10.460 0.660 (1.110) 0.660 0.000 0.000 9.350 70 0 0.000
EX-27.FINANDATASCHED 37
6 27 First Union Money Market Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 117,348,946 117,348,946 774,341 266,050 0 118,389,337 0 0 504,767 504,767 0 117,884,570 95,759,773 88,171,593 0 0 0 0 0 95,759,773 0 4,704,152 0 659,620 4,044,532 0 0 4,044,532 0 3,515,478 0 0 397,451,193 393,034,505 3,171,491 20,598,278 0 0 0 0 372,483 0 1,035,455 107,186,093 1.000 0.040 0.000 0.040 0.000 0.000 1.000 61 0 0.000
EX-27.FINANDATASCHED 38
6 28 First Union Money Market Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 117,348,946 117,348,946 774,341 266,050 0 118,389,337 0 0 504,767 504,767 0 117,884,570 11,721,779 0 0 0 0 0 0 11,721,779 0 4,704,152 0 659,620 4,044,532 0 0 4,044,532 0 156,072 0 0 17,229,258 5,630,031 122,553 20,598,278 0 0 0 0 372,483 0 1,035,455 107,186,093 1.000 0.030 0.000 0.030 0.000 0.000 1.000 130 0 0.000
EX-27.FINANDATASCHED 39
6 29 First Union Money Market Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 117,348,946 117,348,946 774,341 266,050 0 118,389,337 0 0 504,767 504,767 0 117,884,570 10,403,018 9,114,699 0 0 0 0 0 10,403,018 0 4,704,152 0 659,620 4,044,532 0 0 4,044,532 0 372,982 0 0 18,198,890 16,981,481 70,910 20,598,278 0 0 0 0 372,483 0 1,035,455 107,186,093 1.000 0.040 0.000 0.040 0.000 0.000 1.000 41 0 0.000
EX-27.FINANDATASCHED 40
6 30 First Union North Carolina Municipal Bond Port Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 58,054,613 56,090,745 1,395,541 28,487 0 57,514,773 3,501,210 0 776,633 4,277,843 0 60,114,254 871,144 1,200,415 0 0 (4,913,456) 0 (1,963,868) 7,978,824 0 3,392,113 0 726,686 2,665,427 (4,913,456) (3,925,063) (6,173,092) 0 503,283 0 0 417,470 782,865 36,125 (4,669,716) 0 0 0 0 287,040 0 947,965 57,459,852 10.610 0.490 (1.450) 0.490 0.000 0.000 9.160 79 0 0.000
EX-27.FINANDATASCHED 41
6 31 First Union North Carolina Municipal Bond Port Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 58,054,613 56,090,745 1,395,541 28,487 0 57,514,773 3,501,210 0 776,633 4,277,843 0 60,114,254 4,872,069 4,256,330 0 0 (4,913,456) 0 (1,963,868) 44,615,693 0 3,392,113 0 726,686 2,665,427 (4,913,456) (3,925,063) (6,173,092) 0 2,144,310 0 0 1,588,728 1,136,420 163,431 (4,669,716) 0 0 0 0 287,040 0 947,965 57,459,852 10.610 0.440 (1.450) 0.440 0.000 0.000 9.160 137 0 0.000
EX-27.FINANDATASCHED 42
6 32 First Union North Carolina Municipal Bond Port Y Shares 12-MOS Dec-31-1994 Dec-31-1994 58,054,613 56,090,745 1,395,541 28,487 0 57,514,773 2,501,210 0 776,633 4,277,843 0 60,114,254 70,162 0 0 0 (4,913,456) 0 (1,963,868) 642,413 0 3,392,113 0 726,686 2,665,427 (4,913,456) (3,925,063) (6,173,092) 0 17,834 0 0 74,100 4,358 420 (4,669,716) 0 0 0 0 287,040 0 947,965 57,459,852 10.300 0.430 (1.140) 0.430 0.000 0.000 9.160 59 0 0.000
EX-27.FINANDATASCHED 43
6 33 First Union South Carolina Municipal Bond Port Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 3,085,384 2,865,603 55,538 7,014 0 2,928,155 0 0 67,415 67,415 0 3,113,930 36,221 0 0 0 (33,409) 0 (219,781) 312,283 0 102,498 0 14,019 88,479 (33,409) (219,781) (164,711) 0 9,315 0 0 41,168 5,193 246 2,860,740 0 0 0 0 8,905 0 200,311 1,804,750 10.000 0.460 (1.380) 0.460 0.000 0.000 8.620 25 0 0.000
EX-27.FINANDATASCHED 44
6 34 First Union South Carolina Municipal Bond Port Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 3,085,384 2,865,603 55,538 7,014 0 2,928,155 0 0 67,415 67,415 0 3,113,930 284,889 0 0 0 (33,409) 0 (219,781) 2,456,224 0 102,498 0 14,019 88,479 (33,409) (219,781) (164,711) 0 76,164 0 0 304,136 25,441 6,194 2,860,740 0 0 0 0 8,905 0 200,311 1,804,750 10.000 0.410 (1.380) 0.410 0.000 0.000 8.620 87 0 0.000
EX-27.FINANDATASCHED 45
6 35 First Union South Carolina Municipal Bond Port Y Shares 12-MOS Dec-31-1994 Dec-31-1994 3,085,384 2,865,603 55,538 7,014 0 2,928,155 0 0 67,415 67,415 0 3,113,930 10,698 0 0 0 (33,409) 0 (219,781) 92,233 0 102,498 0 14,019 88,479 (33,409) (219,781) (164,711) 0 3,000 0 0 10,721 24 1 2,860,740 0 0 0 0 8,905 0 200,311 1,804,750 9.740 0.430 (1.120) 0.430 0.000 0.000 8.620 0 0 0.000
EX-27.FINANDATASCHED 46
6 36 First Union Tax-Free Money Market Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 427,082,058 427,082,058 4,245,661 0 0 431,327,719 13,102,038 0 1,977,708 15,079,746 0 416,247,973 395,611,690 278,451,285 0 0 0 0 0 395,611,690 0 14,334,342 0 2,625,863 11,708,479 0 0 11,708,479 0 10,293,582 0 0 1,267,792,072 1,153,437,562 2,788,151 134,419,224 0 0 0 0 1,580,216 0 3,429,382 451,490,200 1.000 0.030 0.000 0.030 0.000 0.000 1.000 61 0 0.000
EX-27.FINANDATASCHED 47
6 37 First Union Tax-Free Money Market Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 427,082,058 427,082,058 4,245,661 0 0 431,327,719 13,102,038 0 1,977,708 15,079,746 0 416,247,973 20,636,283 3,377,464 0 0 0 0 0 20,636,283 0 14,334,342 0 2,625,863 11,708,479 0 0 11,708,479 0 1,414,897 0 0 205,425,428 188,148,865 0 134,419,224 0 0 0 0 1,580,216 0 3,429,382 451,490,200 1.000 0.030 0.000 0.030 0.000 0.000 1.000 31 0 0.000
EX-27.FINANDATASCHED 48
6 38 First Union Treasury Money Market Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 919,906,581 919,906,581 4,728,315 25,088 0 924,659,984 0 0 6,689,127 6,689,127 0 917,970,857 755,050,277 261,474,610 0 0 0 0 0 755,050,277 0 31,059,144 0 2,886,497 28,172,647 0 0 28,172,647 0 18,913,691 0 0 2,181,392,175 1,692,374,918 4,558,410 290,387,561 0 0 0 0 2,549,955 0 4,945,841 728,558,327 1.000 0.040 0.000 0.040 0.000 0.000 1.000 50 0 0.000
EX-27.FINANDATASCHED 49
6 39 First Union Treasury Money Market Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 919,906,581 919,906,581 4,728,315 25,088 0 924,659,984 0 0 6,689,127 6,689,127 0 917,970,857 162,920,580 366,108,686 0 0 0 0 0 162,920,580 0 31,059,144 0 2,886,497 28,172,647 0 0 28,172,647 0 9,258,956 0 0 630,963,750 834,151,856 0 290,387,561 0 0 0 0 2,549,955 0 4,945,841 728,558,327 1.000 0.040 0.000 0.040 0.000 0.000 1.000 20 0 0.000
EX-27.FINANDATASCHED 50
6 40 First Union U.S. Government Portfolio Class A 12-MOS Dec-31-1994 Dec-31-1994 257,279,633 233,072,226 3,774,727 107,686 0 236,954,639 0 0 1,817,095 1,817,095 0 266,791,733 2,613,820 3,866,686 0 0 (7,446,782) 0 (24,207,407) 23,705,652 0 21,549,057 0 3,855,865 17,693,192 (5,468,380) (23,253,985) (11,029,173) 0 2,207,479 0 0 593,469 1,959,939 113,604 (54,895,564) 0 (1,978,402) 0 0 1,355,420 0 3,961,388 270,169,757 10.050 0.660 (0.980) 0.660 0.000 0.000 9.070 96 0 0.000
EX-27.FINANDATASCHED 51
6 41 First Union U.S. Government Portfolio Class B 12-MOS Dec-31-1994 Dec-31-1994 257,279,633 233,072,226 3,774,727 107,686 0 236,954,639 0 0 1,817,095 1,817,095 0 266,791,733 21,565,544 23,556,315 0 0 (7,446,782) 0 (24,207,407) 195,570,908 0 21,549,057 0 3,855,865 17,693,192 (5,468,380) (23,253,985) (11,029,173) 0 14,400,952 0 0 4,261,379 7,017,488 765,338 (54,895,564) 0 (1,978,402) 0 0 1,355,420 0 3,961,388 270,169,757 10.050 0.610 (0.980) 0.610 0.000 0.000 9.070 154 0 0.000
EX-27.FINANDATASCHED 52
6 42 First Union U.S. Government Portfolio Class C 12-MOS Dec-31-1994 Dec-31-1994 257,279,633 233,072,226 3,774,727 107,686 0 236,954,639 0 0 1,817,095 1,817,095 0 266,791,733 29,324 0 0 0 (7,446,782) 0 (24,207,407) 265,962 0 21,549,057 0 3,855,865 17,693,192 (5,468,380) (23,253,985) (11,029,173) 0 2,793 0 0 29,225 0 99 (54,895,564) 0 (1,978,402) 0 0 1,355,420 0 3,961,388 270,169,757 9.390 0.200 (0.320) 0.200 0.000 0.000 9.070 171 0 0.000
EX-27.FINANDATASCHED 53
6 43 First Union U.S. Government Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 257,279,633 233,072,226 3,774,727 107,686 0 236,954,639 0 0 1,817,095 1,817,095 0 266,791,733 1,719,550 1,441,612 0 0 (7,446,782) 0 (24,207,407) 15,595,022 0 21,549,057 0 3,855,865 17,693,192 (5,468,380) (23,253,985) (11,029,173) 0 1,081,968 0 0 1,020,057 838,664 96,545 (54,895,564) 0 (1,978,402) 0 0 1,355,420 0 3,961,388 270,169,757 10.050 0.690 (0.980) 0.690 0.000 0.000 9.070 71 0 0.000
EX-27.FINANDATASCHED 54
6 44 First Union Utility Portfolio Class A Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 40,728,944 38,332,674 299,178 35,840 0 38,667,692 0 0 355,966 355,966 0 40,781,719 465,691 0 19,933 0 (93,656) 0 (2,396,270) 4,190,305 1,413,163 261,177 0 323,813 1,350,527 (93,656) (2,396,270) (1,139,399) 0 191,065 0 0 1,050,103 601,659 17,247 38,311,726 0 0 0 0 153,458 0 582,808 31,610,617 10.000 0.450 (1.010) 0.440 0.000 0.000 9.000 53 0 0.000
EX-27.FINANDATASCHED 55
6 45 First Union Utility Portfolio Class B Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 40,728,944 38,332,674 299,178 35,840 0 38,667,692 0 0 355,966 355,966 0 40,781,719 3,197,871 0 19,933 0 (93,656) 0 (2,396,270) 28,792,123 1,413,163 261,177 0 323,813 1,350,527 (93,656) (2,396,270) (1,139,399) 0 922,823 0 0 3,519,138 406,297 85,030 38,311,726 0 0 0 0 153,458 0 582,808 31,610,617 10.000 0.390 (1.010) 0.380 0.000 0.000 9.000 127 0 0.000
EX-27.FINANDATASCHED 56
6 46 First Union Utility Portfolio Class C Investment Shares 12-MOS Dec-31-1994 Dec-31-1994 40,728,944 38,332,674 299,178 35,840 0 38,667,692 0 0 355,966 355,966 0 40,781,719 14,199 0 19,933 0 (93,656) 0 (2,396,270) 127,883 1,413,163 261,177 0 323,813 1,350,527 (93,656) (2,396,270) (1,139,399) 0 1,182 0 0 14,069 0 130 38,311,726 0 0 0 0 153,458 0 582,808 31,610,617 9.330 0.120 (0.330) 0.110 0.000 0.000 9.010 194 0 0.000
EX-27.FINANDATASCHED 57
6 47 First Union Utility Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 40,728,944 38,332,674 299,178 35,840 0 38,667,692 0 0 355,966 355,966 0 40,781,719 577,662 0 19,933 0 (93,656) 0 (2,396,270) 5,201,415 1,413,163 261,177 0 323,813 1,350,527 (93,656) (2,396,270) (1,139,399) 0 210,047 0 5,477 580,992 23,687 20,357 38,311,726 0 0 0 0 153,458 0 582,808 31,610,617 9.510 0.370 (0.500) 0.370 0.000 0.010 9.000 40 0 0.000
EX-27.FINANDATASCHED 58
6 48 First Union Value Portfolio Class A 12-MOS Dec-31-1994 Dec-31-1994 802,372,539 807,634,310 4,234,547 743 0 811,869,600 3,938,539 0 7,314,288 11,252,827 0 796,232,544 11,360,202 10,774,671 0 (434,532) (443,010) 0 5,261,771 188,807,184 27,496,851 2,443,286 0 6,384,245 23,555,892 37,989,054 (46,787,958) 14,756,988 0 5,495,722 8,939,524 0 1,358,029 1,612,008 839,511 87,593,169 0 (131,832) (635,325) 0 3,850,673 0 6,384,245 771,316,305 17.630 0.520 (0.200) 0.510 0.820 0.000 16.620 93 0 0.000
EX-27.FINANDATASCHED 59
6 49 First Union Value Portfolio Class B 12-MOS Dec-31-1994 Dec-31-1994 802,372,539 807,634,310 4,234,547 743 0 811,869,600 3,938,539 0 7,314,288 11,252,827 0 796,232,544 6,274,003 3,400,580 0 (434,532) (443,010) 0 5,261,771 104,298,562 27,496,851 2,443,286 0 6,384,245 23,555,892 37,989,054 (46,787,958) 14,756,988 0 1,952,154 4,906,369 24,340 3,054,952 575,508 393,979 87,593,169 0 (131,832) (635,325) 0 3,850,673 0 6,384,245 771,316,305 17.630 0.420 (0.200) 0.410 0.820 0.000 16.620 153 0 0.000
EX-27.FINANDATASCHED 60
6 50 First Union Value Portfolio Class C 12-MOS Dec-31-1994 Dec-31-1994 802,372,539 807,634,310 4,234,547 743 0 811,869,600 3,938,539 0 7,314,288 11,252,827 0 796,232,544 29,207 0 0 (434,532) (443,010) 0 5,261,771 485,037 27,496,851 2,443,286 0 6,384,245 23,555,892 37,989,054 (46,787,958) 14,756,988 0 2,060 22,671 951 27,701 34 1,540 87,593,169 0 (131,832) (635,325) 0 3,850,673 0 6,384,245 771,316,305 18.280 0.190 (0.810) 0.190 0.820 0.040 16.610 168 0 0.000
EX-27.FINANDATASCHED 61
6 51 First Union Value Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 802,372,539 807,634,310 4,234,547 743 0 811,869,600 3,938,539 0 7,314,288 11,252,827 0 796,232,544 30,516,178 26,269,966 0 (434,532) (443,010) 0 5,261,771 507,025,990 27,496,851 2,443,286 0 6,384,245 23,555,892 37,989,054 (46,787,958) 14,756,988 0 15,879,870 24,431,670 0 10,949,430 8,880,310 2,177,091 87,593,169 0 (131,832) (635,325) 0 3,850,673 0 6,384,245 771,316,305 17.630 0.560 (0.200) 0.560 0.820 0.000 16.610 68 0 0.000
EX-27.FINANDATASCHED 62
6 52 First Union Virginia Municipal Bond Portfolio Class A 12-MOS Dec-31-1994 Dec-31-1994 6,328,243 5,918,576 128,923 11,176 0 6,058,675 247,561 0 44,273 291,834 0 6,435,061 181,494 128,122 0 0 (258,553) 0 (409,667) 1,605,460 0 282,191 0 45,279 236,912 (258,553) (435,700) (457,341) 0 82,301 0 0 86,681 40,827 7,518 2,226,205 0 0 0 0 24,942 0 275,294 5,045,735 10.190 0.470 (1.340) 0.470 0.000 0.000 8.850 53 0 0.000
EX-27.FINANDATASCHED 63
6 53 First Union Virginia Municipal Bond Portfolio Class B 12-MOS Dec-31-1994 Dec-31-1994 6,328,243 5,918,576 128,923 11,176 0 6,058,675 247,561 0 44,273 291,834 0 6,435,061 431,550 219,346 0 0 (258,553) 0 (409,667) 3,817,255 0 282,191 0 45,279 236,912 (258,553) (435,700) (457,341) 0 148,091 0 0 259,308 60,204 13,100 2,226,205 0 0 0 0 24,942 0 275,294 5,045,735 10.190 0.420 (1.340) 0.420 0.000 0.000 8.850 112 0 0.000
EX-27.FINANDATASCHED 64
6 54 First Union Virginia Municipal Bond Portfolio Y Shares 12-MOS Dec-31-1994 Dec-31-1994 6,328,243 5,918,576 128,923 11,176 0 6,058,675 247,561 0 44,273 291,834 0 6,435,061 38,906 0 0 0 (258,553) 0 (409,667) 344,126 0 282,191 0 45,279 236,912 (258,553) (435,700) (457,341) 0 6,520 0 0 42,022 3,209 93 2,226,205 0 0 0 0 24,942 0 275,294 5,045,735 9.830 0.410 (0.980) 0.410 0.000 0.000 8.850 28 0 0.000
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