-----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, f6Yrov63cR3BOPPGlPyKuM6J4sXu8YHNEvrA5LGsF4cbJf3JOW9fgNNZsCrkf3di TD2XFZR8wcc4s/V5UgQhwQ== 0000757440-94-000018.txt : 19940902 0000757440-94-000018.hdr.sgml : 19940902 ACCESSION NUMBER: 0000757440-94-000018 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19940901 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST UNION FUNDS/ CENTRAL INDEX KEY: 0000757440 STANDARD INDUSTRIAL CLASSIFICATION: 0000 IRS NUMBER: 046599663 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 002-94560 FILM NUMBER: 94547626 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 497 1 FORM DOCUMENT FIRST UNION EQUITY AND INCOME FUNDS (Portfolios of First Union Funds) Trust Shares - -------------------------------------------------------------------------------- Supplement to Prospectus dated February 28, 1994 Effective September 1, 1994, First Union Equity and Income Funds (the "Funds"), with the exception of First Union Managed Bond Fund, will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. A. Please delete the "Summary of Fund Expenses" table on pages 4 and 5 and replace it with the following: - ------------------------- SUMMARY OF ------------------------- - ------------------------- FUND EXPENSES ------------------------- FIRST UNION EQUITY AND INCOME FUNDS TRUST SHARES
Fixed High Grade Managed U.S. Balanced Income Tax Free Bond Government Utility Value Fund Fund Fund Fund Fund Fund Fund -------- ------ ---------- ------- ---------- ------- ----- Trust Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)................................ None None None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................................ None 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 None Redemption Fee (as a percentage of amount redeemed, if applicable)..................................................... None None None None None None None Exchange Fee........................................................ None None None None None None None Annual Trust Shares Operating Expenses* (As a percentage of average net assets) Management Fee (after waiver) (1)................................... 0.50% 0.50% 0.49% 0.50% 0.49% 0.00% 0.50% 12b-1 Fees.......................................................... None None None None None None None Total Other Expenses (after waiver) (2)............................. 0.16% 0.16% 0.28% 0.20% 0.25% 0.92% 0.17% Total Trust Shares Operating Expenses (3)......................... 0.66% 0.66% 0.77% 0.70% 0.74% 0.92% 0.67%
(1) The management fees of High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. - ------------------------- SUMMARY OF ------------------------- - ------------------------- FUND EXPENSES ------------------------- (continued) FIRST UNION EQUITY AND INCOME FUNDS TRUST SHARES (2) Total Other Expenses for Managed Bond Fund would have been 0.23%, absent the voluntary waiver by the administrator of certain of its fees. Total Other Expenses for Utility Fund are estimated to be 1.66%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate these voluntary waivers at any time at its sole discretion. (3) The total Trust Shares Operating Expenses for Managed Bond Fund would have been 0.73%, absent the voluntary waiver described above in note 2. Total Trust Shares Operating Expenses for High Grade Tax Free and Utility Funds are estimated to be 0.78% and 2.16%, respectively, absent the anticipated voluntary waivers described above in notes 1 and 2. Fixed Income, U.S. Government and Value Funds' Trust Shares Annual Operating Expenses were 0.66%, 0.48% and 0.65%, respectively, for the year ended December 31, 1993. Total Trust Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser, were 0.79% for the year ended December 31, 1993. The Annual Trust Shares Operating Expenses, except for the Balanced, High Grade Tax Free, Managed Bond, and Utility Funds, in the table above, are based on expenses expected during the fiscal year ending December 31, 1994. Total Trust Shares expected operating expenses for U.S. Government Fund would be 0.75%, absent the voluntary waiver described above in note 1. Fixed Income and Value Funds are no longer allocating certain expenses as incurred by each class. * High Grade Tax Free, U.S. Government and Utility Funds' expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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 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 Trust Shares. Balanced Fund................................ $7 $21 $37 $82 Fixed Income Fund............................ $7 $21 $37 $82 High Grade Tax Free Fund..................... $8 $25 N/A N/A Managed Bond Fund............................ $7 $22 $39 $87 U.S. Government Fund......................... $8 $24 $41 $92 Utility Fund................................. $9 $29 N/A N/A Value Fund................................... $7 $21 $37 $83
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 Trust Shares of High Grade Tax Free, U.S. Government and Utility Funds is based on estimated data for the fiscal year ending December 31, 1994. The information set forth in the foregoing table and example relates only to Trust Shares of the Funds. The Funds (other than Managed Bond Fund) also offer three additional classes of shares called Class B Shares, Class C Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Class B Shares are subject to a 12b-1 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%. Class D 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 B Shares bear a maximum front-end sales charge of 4.75%. Class C Shares bear a maximum contingent deferred sales charge of 5.00% and Class D Shares bear a maximum contingent deferred sales charge of 1.00%. See "Fees and Expenses" and "Other Classes of Shares." September 1, 1994 FEDERATED SECURITIES CORP. - -------------------------------------------------------------------------------- Distributor G00389-13-A (9/94) FIRST UNION - --------------------- EQUITY AND INCOME --------------------- - --------------------- FUNDS --------------------- Portfolios of First Union Funds TRUST SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1994 First Union Funds (the "Trust") is a mutual fund with 15 portfolios, offering a variety of investment opportunities. The Trust currently includes seven diversified Equity and Income Funds, three diversified Money Market Funds, and five non-diversified Single State Municipal Bond Funds. They are: Equity and Income Funds . First Union Balanced Portfolio; . First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio; . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. This prospectus provides you with information specific to the Trust Shares of First Union Equity and Income Funds. It concisely describes the information which you should know before investing in Trust Shares of any of the First Union Equity and Income Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Equity and Income Fund in its Statement of Additional Information dated February 28, 1994, 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 value of investment company shares offered by this prospectus fluctuates daily. 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 "FIRST UNION HIGH GRADE TAX FREE PORTFOLIO--MUNICIPAL BOND INSURANCE," PAGE 19. - -------------------------------------------------------------------------------- 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 SHAREHOLDER GUIDE 31 - -------------------------------------- -------------------------------------- SUMMARY OF FUND EXPENSES 4 HOW TO BUY SHARES 33 - -------------------------------------- -------------------------------------- FINANCIAL HIGHLIGHTS 6 HOW TO CONVERT YOUR INVESTMENT FROM - -------------------------------------- ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND 34 -------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 16 HOW TO REDEEM SHARES 35 - -------------------------------------- -------------------------------------- FIRST UNION BALANCED PORTFOLIO 16 MANAGEMENT OF FIRST UNION FUNDS 35 - -------------------------------------- -------------------------------------- FIRST UNION FIXED INCOME PORTFOLIO 17 FEES AND EXPENSES 37 - -------------------------------------- -------------------------------------- FIRST UNION HIGH GRADE TAX FREE PORTFOLIO 19 SHAREHOLDER RIGHTS AND PRIVILEGES 38 - -------------------------------------- -------------------------------------- FIRST UNION MANAGED BOND PORTFOLIO 21 DISTRIBUTIONS AND TAXES 39 - -------------------------------------- -------------------------------------- FIRST UNION U.S. GOVERNMENT PORTFOLIO 22 TAX INFORMATION 40 - -------------------------------------- -------------------------------------- FIRST UNION UTILITY PORTFOLIO 24 OTHER CLASSES OF SHARES 41 - -------------------------------------- -------------------------------------- FIRST UNION VALUE PORTFOLIO 26 ADDRESSES Inside Back Cover - -------------------------------------- -------------------------------------- OTHER INVESTMENT POLICIES 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 15 portfolios, each representing a different First Union Fund. Each Equity and Income Fund, except First Union Managed Bond Portfolio, is divided into three classes of shares: Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares"), and Trust Shares. Trust Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). Class B and Class C Shares are sold to individuals and other customers of First Union (the "Adviser"). First Union Managed Bond Portfolio presently offers only Trust Shares. This prospectus relates only to Trust Shares ("Shares") of First Union Equity and Income Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following seven Funds: . FIRST UNION BALANCED PORTFOLIO ("BALANCED FUND")--seeks to produce long-term total return through capital appreciation, dividends, and interest income; . 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 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; . FIRST UNION MANAGED BOND PORTFOLIO ("MANAGED BOND FUND")--seeks to achieve total return; . FIRST UNION U.S. GOVERNMENT PORTFOLIO ("U.S. GOVERNMENT FUND")--seeks a high level of current income consistent with stability of principal; . 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 Trust 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 several of the Funds described in this prospectus, may vary inversely in response to changes in prevailing interest rates. The foreign securities in which several 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 EQUITY AND INCOME FUNDS TRUST SHARES
Fixed High Grade Managed U.S. Balanced Income Tax Free Bond Government Utility Value Fund Fund Fund Fund Fund Fund Fund -------- ------ ---------- ------- ---------- ------- ----- TRUST SHARES-- SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offering price).......... None None None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price). None None None None None None None Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable).... None None None None None None None Redemption Fee (as a per- centagE of amount redeemed, if applicable). None None None None None None None Exchange Fee.... None None None None None None None ANNUAL TRUST SHARES OPERATING EXPENSES* (As a percentage of average net assets) Management Fee (after waiver) (1).... 0.50% 0.50% 0.49% 0.50% 0.49% 0.00% 0.50% 12b-1 Fees..... None None None None None None None Total Other Expenses (after waiver) (2)... 0.16% 0.16% 0.28% 0.20% 0.25% 0.92% 0.17% Total Trust Shares Operating Expenses (3). 0.66% 0.66% 0.77% 0.70% 0.74% 0.92% 0.67%
(1) The management fees of High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (2) Total Other Expenses for Managed Bond Fund would have been 0.23%, absent the voluntary waiver by the administrator of certain of its fees. Total other expenses for Utility Fund are estimated to be 1.66% absent the anticipated voluntary waiver by the administrator. The administrator may terminate these voluntary waivers at any time at its sole discretion. (3) The total Trust Shares Operating Expenses for Managed Bond Fund would have been 0.73%, absent the voluntary waiver described above in note 2. Total Trust Shares Operating Expenses for High Grade Tax Free and Utility Funds are estimated to be 0.78% and 2.16%, respectively absent the anticipated voluntary waivers described in notes 1 and 2. Fixed Income, U.S. Government and Value Funds' Trust Shares Annual Operating Expenses were 0.66%, 0.48% and 0.65%, respectively, for the year ended December 31, 1993. Total Trust Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser, were 0.79% for the year ended December 31, 1993. The Annual Trust Shares Operating Expenses, except for the Balanced, High Grade Tax Free, Managed Bond, and Utility Funds, in the table above, are based on expenses expected during the fiscal year ending December 31, 1994. Total Trust Shares expected operating expenses for U.S. Government Fund would be 0.75%, absent the voluntary waiver described above in note 1. Fixed Income and Value Funds are no longer allocating certain expenses as incurred by each class. * High Grade Tax Free, U.S. Government and Utility Funds' expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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. - ------------------------ SUMMARY OF ------------------------ - ------------------------ FUND EXPENSES ------------------------ (CONTINUED) FIRST UNION EQUITY AND INCOME FUNDS TRUST 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 Trust Shares. Balanced Fund................................ $7 $21 $37 $82 Fixed Income Fund............................ $7 $21 $37 $82 High Grade Tax Free Fund..................... $8 $25 NA NA Managed Bond Fund............................ $7 $22 $39 $87 U.S. Government Fund......................... $8 $24 NA NA Utility Fund................................. $9 $29 NA NA Value Fund................................... $7 $21 $37 $83
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 TRUST SHARES OF HIGH GRADE TAX FREE, U.S. GOVERNMENT, AND UTILITY FUNDS IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. The information set forth in the foregoing table and example relates only to Trust Shares of the Funds. The Funds (other than Managed Bond Fund) also offer two additional classes of shares called Class B Shares and Class C Shares. In general, all expenses are allocated based upon daily net assets of each class. Class B Shares are subject to a 12b-1 fee of .25 of 1% and Class C Shares are subject to a 12b-1 fee of .75 of 1%. In addition, Class B Shares bear a maximum front-end sales load of 4.00% while Class C Shares bear a maximum contingent deferred sales load of 4.00%. See "Fees and Expenses" and "Other Classes of Shares." - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION BALANCED PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES CLASS B INVESTMENT SHARES ---------------------------- ------------------------------- YEAR ENDED YEAR ENDED ---------------------------- ------------------------------- 12/31/93 12/31/92 12/31/91** 12/31/93 12/31/92 12/31/91*** - ------------------ -------- -------- ---------- -------- -------- ----------- NET ASSET VALUE, BEGINNING OF PERIOD $11.41 $11.02 $10.00 $11.41 $11.02 $10.00 - ------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------ Net investment income 0.45 0.46 0.36 0.419 0.42 0.30 - ------------------ Net realized and unrealized gain (loss) on investments 0.75 0.42 1.03 0.755 0.43 1.08 - ------------------ ------ ------ ------ ------- ------ ------ Total from investment operations 1.20 0.88 1.39 1.174 0.85 1.38 - ------------------ ------ ------ ------ ------- ------ ------ LESS DISTRIBUTIONS - ------------------ Dividends to shareholders from net investment income (0.45) (0.45) (0.36) (0.419) (0.42) (0.35) - ------------------ Distributions to shareholders from net realized gain on investment transactions (0.09) (0.04) (0.01) (0.091) (0.04) (0.01) - ------------------ Distributions in excess of net investment income -- -- -- (0.004)(b) -- -- - ------------------ ------ ------ ------ ------- ------ ------ Total distributions (0.54) (0.49) (0.37) (0.514) (0.46) (0.36) - ------------------ ------ ------ ------ ------- ------ ------ NET ASSET VALUE, END OF PERIOD $12.07 $11.41 $11.02 $12.07 $11.41 $11.02 - ------------------ ------ ------ ------ ------- ------ ------ TOTAL RETURN* 10.68% 8.21% 15.02% 10.41% 7.94% 11.75% - ------------------ RATIOS TO AVERAGE NET ASSETS - ------------------ Expenses 0.66% 0.66% 0.68%(a) 0.91% 0.91% 0.92%(a) - ------------------ Net investment income 3.86% 4.20% 4.86%(a) 3.61% 3.93% 4.38%(a) - ------------------ SUPPLEMENTAL DATA - ------------------ Net assets, end of period (000 omitted) $760,147 $520,232 $247,472 $35,032 $17,408 $334 - ------------------ Portfolio turnover rate 19% 12% 19% 19% 12% 19% - ------------------
(See notes on page 7.) (CONTINUED) - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- (CONTINUED) FIRST UNION BALANCED PORTFOLIO
CLASS C INVESTMENT SHARES ---------- YEAR ENDED ---------- 12/31/93+ - ---------------------------------------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $11.54 - ---------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------------------------- Net investment income 0.34 - ---------------------------------------- Net realized and unrealized gain (loss) 0.65 on investments ------ - ---------------------------------------- Total from investment operations 0.99 - ---------------------------------------- ------ LESS DISTRIBUTIONS - ---------------------------------------- Dividends to shareholders from net investment income (0.34) - ---------------------------------------- Distributions to shareholders from net realized gain on investment transac- tions (0.09) - ---------------------------------------- Distributions in excess of net investment income (0.02)(b) - ---------------------------------------- ------ Total distributions (0.45) - ---------------------------------------- ------ NET ASSET VALUE, END OF PERIOD $12.08 - ---------------------------------------- ------ TOTAL RETURN* 8.72% - ---------------------------------------- RATIOS TO AVERAGE NET ASSETS - ---------------------------------------- Expenses 1.41%(a) - ---------------------------------------- Net investment income 3.09%(a) - ---------------------------------------- SUPPLEMENTAL DATA - ---------------------------------------- Net assets, end of period (000 omitted) $65,475 - ---------------------------------------- Portfolio turnover rate 19% - ----------------------------------------
* Based on net asset value, which does not reflect the sales load or contin- gent deferred sales charge, if applicable. ** Reflects operations for the period from April 1, 1991 (commencement of op- erations) to December 31, 1991. *** Reflects operations for the period from June 10, 1991 (commencement of op- erations) to December 31, 1991. + Reflects operations for the period from January 26, 1993 (commencement of operations) to December 31, 1993. (a) Computed on an annualized basis. (b) Distributions in excess of net investment income for the year ended Decem- ber 31, 1993 were the result of certain book and tax timing differences. These distributions do not represent a return of capital for federal in- come tax purposes. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION FIXED INCOME PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES --------------------------- PERIOD ENDED --------------------------- 12/31/93 12/31/92 12/31/91* - ------------------------ -------- -------- --------- NET ASSET VALUE, BEGINNING OF PERIOD $10.41 $10.54 $10.06 - ------------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------------ Net investment income 0.69 0.70 0.71 - ------------------------ Net realized and unrealized gain (loss) on investments 0.19 (0.02) 0.56 - ------------------------ ------ ------ ------ Total from investment operations 0.88 0.68 1.27 - ------------------------ ------ ------ ------ LESS DISTRIBUTIONS - ------------------------ Dividends to shareholders from net investment income (0.68) (0.70) (0.71) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions (0.18) (0.11) (0.07) - ------------------------ Distributions in excess of net investment in- come -- -- (0.01)(a) - ------------------------ ------ ------ ------ Total distributions (0.86) (0.81) (0.79) - ------------------------ ------ ------ ------ NET ASSET VALUE, END OF PERIOD $10.43 $10.41 $10.54 - ------------------------ ------ ------ ------ TOTAL RETURN** 8.67% 6.64% 13.80% - ------------------------ RATIOS TO AVERAGE NET ASSETS - ------------------------ Expenses 0.66% 0.69% 0.69%(c) - ------------------------ Net investment income 6.41% 6.67% 7.12%(c) - ------------------------ Expense waiver/ reimbursement (b) -- -- 0.07%(c) - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of period (000 omitted) $376,445 $324,068 $256,254 - ------------------------ Portfolio turnover rate 73% 66% 55% - ------------------------
CLASS B INVESTMENT SHARES ------------------------------------------------------- PERIOD ENDED ------------------------------------------------------- 12/31/93 12/31/92 12/31/91 12/31/90+ /31/90 3/31/89++ - ------------------------ -------- -------- -------- --------- ------ --------- C> NET ASSET VALUE, BEGINNING OF PERIOD $10.41 $10.54 $ 9.99 $9.72 $9.50 $9.70 - ------------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------------ Net investment income 0.65 0.71 0.73 0.55 0.79 0.10 - ------------------------ Net realized and unrealized gain (loss) on investments 0.19 (0.06) 0.60 0.24 0.20 (0.14) - ------------------------ ------ ------ ------ ----- ----- ----- Total from investment operations 0.84 0.65 1.33 0.79 0.99 (0.04) - ------------------------ ------ ------ ------ ----- ----- ----- LESS DISTRIBUTIONS - ------------------------ Dividends to shareholders from net investment income (0.65) (0.67) (0.70) (0.52) (0.77) (0.16) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions (0.18) (0.11) (0.07) -- -- -- - ------------------------ Distributions in excess of net investment in- come -- -- (0.01)(a) -- -- -- - ------------------------ ------ ------ ------ ----- ----- ----- Total distributions (0.83) (0.78) (0.78) (0.52) (0.77) (0.16) - ------------------------ ------ ------ ------ ----- ----- ----- NET ASSET VALUE, END OF PERIOD $10.42 $10.41 $10.54 $9.99 $9.72 $9.50 - ------------------------ ------ ------ ------ ----- ----- ----- TOTAL RETURN** 8.29% 6.39% 13.74% 8.31% 10.51% (0.31%) - ------------------------ RATIOS TO AVERAGE NET ASSETS - ------------------------ Expenses 0.93% 0.90% 0.80% 1.01%(c) 1.00% 1.78%(c) - ------------------------ Net investment income 6.15% 6.79% 7.30% 7.53%(c) 7.57% 6.10%(c) - ------------------------ Expense waiver/ reimbursement (b) -- -- 0.09% 0.81%(c) 0.50% -- - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of period (000 omitted) $22,865 $21,488 $17,680 $11,765 $6,496 $11,580 - ------------------------ Portfolio turnover rate 73% 66% 55% 27% 32% 18% - ------------------------
(See notes on page 9.) (CONTINUED) - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- (CONTINUED) FIRST UNION FIXED INCOME PORTFOLIO
CLASS C INVESTMENT SHARES ----------- PERIOD ENDED ----------- 12/31/93+++ - ------------------------------- ----------- NET ASSET VALUE, BEGINNING OF PERIOD $10.57 - ------------------------------- INCOME FROM INVESTMENT OPERA- TIONS - ------------------------------- Net investment income 0.58 - ------------------------------- Net realized and unrealized gain (loss) on investments 0.05 - ------------------------------- ------ Total from investment operations 0.63 - ------------------------------- ------ LESS DISTRIBUTIONS - ------------------------------- Dividends to shareholders from net investment income (0.58) - ------------------------------- Distributions to shareholders from net realized gain on in- vestments (0.18) - ------------------------------- Distributions in excess of net investment income -- - ------------------------------- ------ Total distributions (0.76) - ------------------------------- ------ NET ASSET VALUE, END OF PERIOD $10.44 - ------------------------------- ------ TOTAL RETURN** 6.08% - ------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------- Expenses 1.57%(c) - ------------------------------- Net investment income 5.42%(c) - ------------------------------- Expense waiver/reimbursement (b) -- - ------------------------------- SUPPLEMENTAL DATA - ------------------------------- Net assets, end of period (000 omitted) $8,876 - ------------------------------- Portfolio turnover rate 73% - -------------------------------
* 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 sales load or contingent deferred sales charge, if applicable. + Nine months ended December 31, 1990. ++ Reflects operations for the period from January 28, 1989 (commencement of operations) to March 31, 1989. +++ Reflects operations for the period from January 26, 1993 (commencement of operations) to December 31, 1993. (a) 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 differences did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ FIRST UNION HIGH GRADE TAX FREE PORTFOLIO (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS C INVESTMENT CLASS B INVESTMENT SHARES (C) SHARES (C) ------------------------------------ ------------------- YEAR ENDED PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993 DECEMBER 31, 1992* DECEMBER 31, 1993** - ---------------------- ----------------- ------------------ ------------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.42 $10.00 $10.42 - ---------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------- Net investment income 0.54 0.51 0.47 - ---------------------- Net realized and unrealized gain on investments 0.81 0.42 0.81 - ---------------------- ------ ------ ------ Total from investment operations 1.35 0.93 1.28 - ---------------------- LESS DISTRIBUTIONS - ---------------------- Dividends to share- holders from net investment income (0.54) (0.51) (0.47) - --------------------- Distributions to shareHolders from net realized gain on investment transactions (0.07) -- (0.07) - --------------------- ------ ------ ------ Total distributions (0.61) (0.51) (0.54) - --------------------- ------ ------ ------ NET ASSET VALUE, END OF PERIOD $11.16 $10.42 $11.16 - --------------------- ------ ------ ------ TOTAL RETURN*** 13.25% 9.37% 12.41% - --------------------- RATIOS TO AVERAGE NET ASSETS - --------------------- Expenses 0.85% 0.49%(a) 1.35%(a) - --------------------- Net investment income 4.99% 5.79%(a) 4.44%(a) - --------------------- Expense waiver/reimbursement (b) 0.22% 0.62%(a) 0.22%(a) - --------------------- SUPPLEMENTAL DATA - --------------------- Net assets, end of period (000 omitted) $101,352 $90,738 $41,030 - --------------------- Portfolio turnover rate 14% 7% 14% - ---------------------
* 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 contin- gent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such shares. The Financial High- lights presented above are historical information for Class B and Class C Investment Shares of the Fund. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ---------------------- FIRST UNION MANAGED BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES(C) -------------------------------- YEAR ENDED DECEMBER 31 PERIOD ENDED ------------------ ------------ 1993 1992 12/31/91* - --------------------------------------------- -------- -------- ------------ NET ASSET VALUE, BEGINNING OF PERIOD $10.34 $10.60 $10.00 - --------------------------------------------- INCOME FROM INVESTMENT OPERATIONS - --------------------------------------------- Net investment income 0.65 0.66 0.49 - --------------------------------------------- Net realized and unrealized gain (loss) on investments 0.43 (0.08) 0.63 - --------------------------------------------- ------ ------- ------ Total from investment operations 1.08 0.58 1.12 - --------------------------------------------- ------ ------ ------ LESS DISTRIBUTIONS - --------------------------------------------- Dividends to shareholders from net invest- ment income (0.65) (0.66) (0.49) - --------------------------------------------- Distributions to shareholders from net real- ized gains on investment transactions (0.31) (0.18) (0.03) - --------------------------------------------- ------- ------- ------- Total distributions (0.96) (0.84) (0.52) - --------------------------------------------- ------- ------- ------- NET ASSET VALUE, END OF PERIOD $10.46 $10.34 $10.60 - --------------------------------------------- ------ ------ ------ TOTAL RETURN** 10.59% 5.65% 11.63% - --------------------------------------------- RATIOS TO AVERAGE NET ASSETS - --------------------------------------------- Expenses 0.70% 0.70% 0.70%(a) - --------------------------------------------- Net investment income 6.02% 6.30% 6.57%(a) - --------------------------------------------- Expenses waiver/reimbursement (b) 0.03% 0.05% -- - --------------------------------------------- SUPPLEMENTAL DATA - --------------------------------------------- Net assets, end of period (000 omitted) $109,067 $121,655 $65,638 - --------------------------------------------- Portfolio turnover rate 53% 56% 17% - ---------------------------------------------
* Reflects operations for the period from April 1, 1991 (commencement of oper- ations) to December 31, 1991. ** Based on net asset value, which does not reflect sales load or contingent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) This expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Class B and Class C Investment Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such shares. The Financial Highlights presented above are historical information for Trust Shares of the Fund. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION U.S. GOVERNMENT PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C TRUST INVESTMENT INVESTMENT SHARES SHARES SHARES ------------ ------------ ------------ PERIOD ENDED PERIOD ENDED PERIOD ENDED 12/31/93* 12/31/93** 12/31/93** - --------------------------------- ------------ ------------ ------------ NET ASSET VALUE, BEGINNING OF PE- RIOD $10.25 $10.00 $10.00 - --------------------------------- INCOME FROM INVESTMENT OPERATIONS - --------------------------------- Net investment income .25 .68 .63 - --------------------------------- Net realized and unrealized gain (loss) on investments (.20) .05 .05 - --------------------------------- ------- ------ ------ Total from investment operations .05 .73 .68 - --------------------------------- LESS DISTRIBUTIONS - --------------------------------- Dividends to shareholders from net investment income (.25) (.68) (.63) - --------------------------------- ------- ------- ------- NET ASSET VALUE, END OF PERIOD $10.05 $10.05 $10.05 - --------------------------------- ------ ------ ------ TOTAL RETURN*** 0.49% 7.43% 6.91% - --------------------------------- RATIOS TO AVERAGE NET ASSETS - --------------------------------- Expenses .48%(a) .69%(a) 1.19%(a) - --------------------------------- Net investment income 7.20%(a) 6.93%(a) 6.44%(a) - --------------------------------- Expense adjustment (b) .31%(a) .31%(a) .31%(a) - --------------------------------- SUPPLEMENTAL DATA - --------------------------------- Net assets, end of period (000 omitted) $14,486 $38,851 236,696 - --------------------------------- Portfolio turnover rate 39% 39% 39% - ---------------------------------
* 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. *** Based on net asset value, which does not reflect the sales load or contin- gent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) The voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ FIRST UNION VALUE PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES ---------------------------------- PERIOD ENDED ---------------------------------- 12/31/93 12/31/92 12/31/91* - ------------------------------------------- -------- -------- ----------- NET ASSET VALUE, BEGINNING OF PERIOD $17.11 $17.08 $14.28 - ------------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ------------------------------------------- Net investment income 0.52 0.49 0.47 - ------------------------------------------- Net realized and unrealized gain (loss) on investments 1.12 0.90 3.53 - ------------------------------------------- ------ ------ ------ Total from investment operations 1.64 1.39 4.00 - ------------------------------------------- ------ ------ ------ LESS DISTRIBUTIONS - ------------------------------------------- Dividends to shareholders from net invest- ment income (0.52) (0.49) (0.47) - ------------------------------------------- Distributions to shareholders form net re- alized gain on investment transactions (0.58) (0.87) (0.73) - ------------------------------------------- Distributions in excess of net investment income (0.02)(c) -- -- - ------------------------------------------- ------- ------ ------ Total distributions (1.12) (1.36) (1.20) - ------------------------------------------- ------- ------- ------- NET ASSET VALUE, END OF PERIOD $17.63 $17.11 $17.08 - ------------------------------------------- ------ ------ ------ TOTAL RETURN** 9.71% 8.31% 25.41% - ------------------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------------------- Expenses 0.65% 0.68% 0.69%(b) - ------------------------------------------- Net investment income 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) $463,087 $326,154 271,391 - ------------------------------------------- Portfolio turnover rate 46% 56% 69% - -------------------------------------------
* For the period from January 3, 1991 (commencement of operations) to Decem- ber 31, 1991. ** Based on net asset value, which does not reflect the sales load or contin- gent 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. (c) Distributions in excess of net investment income for the period ended De- cember 31, 1993, were the result of certain book and tax timing differ- ences. These distributions do not represent a return of capital for fed- eral income tax purposes. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION VALUE PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B INVESTMENT SHARES ----------------------------------------------------------------------------------------------- PERIOD ENDED ----------------------------------------------------------------------------------------------- 12/31/93 12/31/92 12/31/91 12/31/90** 3/31/90 3/31/89 3/31/88 3/31/87 3/31/86 3/31/85*** - ------------------------ -------- -------- -------- ---------- ------- ------- ------- ------- ------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $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 0.47 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 invest- ments 1.10 0.89 3.17 (0.44) 1.70 2.11 (1.30) 2.38 2.32 0.00 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------ Total from investment operations 1.57 1.33 3.63 (0.08) 2.24 2.47 (1.04) 2.53 2.51 0.04 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------ LESS DISTRIBUTIONS - ------------------------ Dividends to sharehold- ers from net investment income (0.47) (0.43) (0.43) (0.36) (0.57) (0.38) (0.26) (0.13) (0.20) (0.00) - ------------------------ Distribution to share- holders from net real- ized gain on investments (0.58) (0.87) (0.73) (0.02) (1.00) (0.47) (0.53) (0.09) (0.00) (0.00) - ------------------------ Distributions in excess of net investment income -- -- -- (0.05)(a) -- -- -- -- -- -- - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------ Total distributions (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 $17.63 $17.11 $17.08 $14.61 $15.12 $14.45 $12.83 $14.66 $12.35 $10.04 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------- ------ ------ TOTAL RETURN* 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 0.99% 1.01% 0.96% 1.39%(b) 1.55% 1.71% 1.74% 1.97% 2.00% 2.00%(b) - ------------------------ Net investment income 2.63% 2.57% 2.78% 3.28%(b) 3.42% 2.72% 1.92% 1.41% 2.34% 6.47%(b) - ------------------------ Expense waiver/reimbursement (d) -- 0.01% 0.09% -- -- -- -- -- -- -- - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of pe- riod (000 omitted) $189,983 $169,310 $135,565 $104,637 $95,995 $83,121 $21,914 $23,221 $5,595 $100 - ------------------------ Portfolio turnover rate**** 46% 56% 69% 13% 11% 24% 16% 20% 20% 0% - ------------------------
(See notes on page 15.) (CONTINUED) - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ (CONTINUED) FIRST UNION VALUE PORTFOLIO
CLASS C INVESTMENT SHARES ---------- PERIOD ENDED ---------- 12/31/93+ - ------------------------------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $17.24 - ------------------------------- INCOME FROM INVESTMENT OPERA- TIONS - ------------------------------- Net investment income 0.35 - ------------------------------- Net realized and unrealized gain/(loss) on investments 1.01 - ------------------------------- ------- Total from investment operations 1.36 - ------------------------------- ------- LESS DISTRIBUTIONS - ------------------------------- Dividends to shareholders from net investment income (0.35) - ------------------------------- Distribution to shareholders from net realized gain on in- vestments (0.58) - ------------------------------- Distributions in excess of net investment income (0.04)(c) - ------------------------------- ------- Total distributions (0.97) - ------------------------------- ------- NET ASSET VALUE, END OF PERIOD $17.63 - ------------------------------- ------- TOTAL RETURN* 7.98% - ------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------- Expenses 1.48%(b) - ------------------------------- Net investment income 2.09%(b) - ------------------------------- Expense waiver/reimbursement (d) -- - ------------------------------- SUPPLEMENTAL DATA - ------------------------------- Net assets, end of period (000 omitted) $59,953 - ------------------------------- Portfolio turnover rate**** 46% - -------------------------------
* Based on net asset value, which does not reflect the sales load or con- tingent deferred sales charge, if applicable. ** For the nine months ended December 31, 1990. ***Reflects operations for the period from August 30, 1984 (commencement of operations) to March 31, 1985. ****Portfolio turnover rate for periods ending on or after March 31, 1986 include certain U.S. government obligations. + Reflects operations for the period from February 2, 1993 (commencement of operations) to December 31, 1993. (a) Distributions in excess of net investment income for the period ended December 31, 1990, were a result of certain book and tax timing differ- ences. These distributions did not represent a return of capital for federal income tax purposes for the year ended December 31, 1990. (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 dif- ferences. These distributions do not represent a return of capital for federal income tax purposes. (d) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- INVESTMENT ------------------------- OBJECTIVES - ------------------------- AND POLICIES ------------------------- First Union Equity 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 investment grade equity and fixed income investments. Key Benefits: 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, 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 Corporation ("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 Federal Home Loan Banks, Federal National Mortgage Association, Government National Mortgage Association, Banks for Cooperatives, Federal Farm Credit Banks, Tennessee Valley Authority, Export-Import Bank of the United States, Commodity Credit Corporation, Federal Financing Bank, Student Loan Marketing Association, Federal Home Loan Mortgage Corporation, or 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 ------------------------- 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 The Fund will only invest its assets in 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 or stripped bonds, debentures, notes, U.S. government securities, and debt securities convertible into, or exchangeable for, preferred or common stock. Stated final maturity for these securities may range up to 30 years. The duration of the securities will not exceed ten years. The Fund intends to maintain a dollar-weighted average maturity of five 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 as described under the caption "First Union Balanced Portfolio--Types of Investments"; and (5) repurchase agreements collateralized by any security listed above. 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 ------------------------ - ------------------------ HIGH GRADE TAX FREE ------------------------ PORTFOLIO (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) Objective: High level of federally tax free income that is consistent with preservation of capital. Invests in: Insured municipal bonds. Suitable for: Investors seeking high tax-free monthly income and greater liquidity. Key Benefit: Greater diversification and liquidity than purchasing municipal bonds directly. Pays monthly dividends for those who need current income. DESCRIPTION OF THE FUND The High Grade Tax Free Fund seeks a high level of federally tax free income that is consistent with preservation of capital. The Fund pursues this objective by investing primarily in a portfolio of insured municipal bonds. At least 65% of the value of its total assets will be invested in insured obligations. The insurance guarantees the timely payment of principal and interest but not the value of the municipal bonds or shares of the Fund. As a matter of investment policy, which cannot be changed without the approval of shareholders, the Fund 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 income 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 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 the Fund in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The municipal bonds in which the Fund may invest are subject to the following quality standards: rated A or better by Moody's or S&P, or, if unrated, determined by the Adviser to be of comparable quality to such rated bonds; or, insured by a municipal bond insurance company which is rated Aaa by Moody's or AAA by S&P. A description of the rating categories is contained in the Appendix of the Fund's Statement of Additional Information. TEMPORARY INVESTMENTS 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 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; 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 acceptable investments of the Fund. Although the Fund is permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal income tax. The Fund may also purchase investments 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 (lender) 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 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 bonds 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 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. The purpose of municipal bond insurance is to guarantee the timely payment of principal at maturity and interest. MUNICIPAL BOND INSURANCE At least 65% of the Fund's total assets will be invested in municipal securities which are insured for timely payment of principal at maturity and interest. The Fund will require insurance when purchasing municipal securities which would not otherwise meet the Fund's quality standards. The 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. Securities in the 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 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 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 insurance policies reduce the yield to shareholders. - ------------------------- FIRST UNION ------------------------- MANAGED BOND - ------------------------- PORTFOLIO ------------------------- Objective: Total return. Invests in: Investment grade corporate bonds and U.S. government and agency bonds. Suitable for: Conservative investors looking for bond interest and appreciation. Key Benefits: 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 investment 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 investment 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; securities which are either issued or guaranteed by the U.S. government, its agencies, or instrumentalities, as more fully described under "First Union Balanced 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 invest temporarily 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 issued or guaranteed by the U.S. government, its agencies or instrumentalities ("U.S. government securities"). 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 The Fund may invest in: U.S. government securities. These include: (1) securities which are backed by the full faith and credit of the U.S. government (for example, U.S. Treasury bills, notes, and bonds); (2) obligations issued or guaranteed by U.S. government agencies and instrumentalities, which are supported by any of the following: (a) the full faith and credit of the U.S. government (such as participation certificates guaranteed by Government National Mortgage Association or Federal Housing Administration debentures), (b) the right of the issuer to borrow an amount limited to a specific line of credit from the U.S. government (for example, obligations of Federal Home Loan Banks); (c) discretionary authority of the U.S. government to purchase the issuer's obligations (for example, obligations of the Federal National Mortgage Association); (d) the credit of the instrumentality or agency issuing the obligations (for example, obligations of the Tennessee Valley Authority, the Bank for Cooperatives and the Federal Home Loan Mortgage Corporation); Securities representing ownership interest in mortgage pools ("mortgage- backed securities"). The yield and maturity characteristics of these 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 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; 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 in cash and cash items including such short-term obligations as: commercial paper; obligations issued 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 securities of utility companies. 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. 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; 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."); 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; 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, and 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; 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 (for up to 5% of its net assets); zero coupon bonds issued or guaranteed by the U.S. government, its agencies or instrumentalities (for 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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), 15% (in the case of the Fixed Income, High Grade Tax Free, and Utility Funds) or one-third (in the case of the U.S. Government Fund) of the value of their total assets. FOREIGN INVESTMENTS The Balanced, Fixed Income, Utility, and Value Funds 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 U.S. Government Fund 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 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 U.S. Government Fund receives 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 collateralized mortgage obligations, 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 U.S. Government Fund 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 U.S. Government Fund 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. OPTIONS AND FUTURES All of 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, interest rate or exchange rate risk. The Funds do not use these transactions for speculation or leverage. Options and futures may be volatile investments and involve certain risks which might result in lowering the Funds' returns. The three principal areas of risk include: (1) lack of a liquid secondary market for a futures or option contract when the Fund wants to close out its position; (2) imperfect correlation of changes in the prices of futures or options contracts with the prices of the securities in the Fund's portfolio; and (3) incorrect forecasts by the Adviser of interest rates, market values or other economic factors. In these events, the Fund may lose money on the futures contract or option. 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 10% (in the case of Value Fund), 15% (in the case of the Balanced, Fixed Income, High Grade Tax Free, Managed Bond, and Utility 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. Balanced, Fixed Income, High Grade Tax Free, Managed Bond, and Value Funds may invest up to 10% of their net assets in illiquid securities. U.S. Government and Utility Funds may invest up to 15% of their net assets in illiquid securities. With respect to the Balanced, Fixed Income, Managed Bond, U.S. Government, 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 High Grade Tax Free and Value Funds, illiquid securities include repurchase agreements providing for settlement in more than seven days after notice and certain restricted securities. 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 and Managed 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. "NON-ACTIVE" SECURITIES The Fixed Income, High Grade Tax Free, and Value Funds will not invest more than 10% of their net assets in securities for which an active and substantial market does not exist, along with investments in illiquid securities, restricted securities, securities for which market quotations are not readily available, and repurchase agreements maturing in more than seven days. WARRANTS The Balanced, Fixed Income, High Grade Tax Free, Managed Bond and Value Funds 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 (NAV), 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 Trust Shares of a Fund may differ slightly from that of Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges 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 Trust Shares. It is generally reported using total return, yield, and tax equivalent yield (for the High Grade Tax Free 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 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 Trust 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 High Grade Tax Free Fund may advertise the tax equivalent yield, which 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 Trust 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 Trust Shares, Class B Shares and Class C Shares of a Fund. Because Class B Shares and Class C Shares are subject to 12b-1 fees, the yield and tax equivalent yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, 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 C 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 any of the Funds. There are no sales charges imposed on Trust 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 Trust 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, State Street Bank and Trust Company of Boston, Massachusetts ("State Street Bank") 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 Trust Shares of one First Union Fund for Trust 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their net asset value determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 $70.8 billion in total consolidated assets as of December 31, 1993. Through offices in 36 states and one foreign country, 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 $43.0 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. 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. 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. 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 High Grade Tax Free Fund since its inception in February 1992. 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. Malcolm M. Trevillian is a Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1986. During that time, he has served as a portfolio manager for various pension and profit-sharing accounts maintained with First Union. Mr. Trevillian has managed the Utility Fund since its inception in January 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., 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"), 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 serves as custodian and transfer agent, providing 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 Equity 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 TRUST 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 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; 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, 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 4, 1994, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 63,510,816 shares (98.9%) of the Balanced Fund-Trust Shares; 35,104,402 shares (95.1%) of Fixed Income Fund- Trust Shares; 10,269,556 shares (98.7%) of Managed Bond Fund-Trust Shares; 25,746,543 shares (96.0%) of Value Fund-Trust Shares; 1,221,044 shares (81.5%) of U.S. Government Fund-Trust Shares; and 501,994 shares (80.44%) of Utility Fund-Class B 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. - ------------------------- 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; dividends are declared and paid monthly for the Fixed Income, Managed Bond, and Utility Funds; and dividends are declared daily and paid monthly for the High Grade Tax Free and U.S. Government 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 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 "High Grade Tax Free 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. HIGH GRADE TAX FREE FUND ADDITIONAL TAX INFORMATION Shareholders of High Grade Tax Free 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. Distributions representing net long-term capital gains realized by the Fund, 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. - ------------------------- OTHER CLASSES ------------------------- - ------------------------- OF SHARES ------------------------- First Union Equity and Income Funds offer three classes of shares: Trust Shares for institutional investors and Class B Shares and Class C Shares for individuals and other customers of First Union. Class B Shares and Class C Shares of First Union Equity and Income 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 B Shares), or (ii) on a contingent deferred basis (the Class C Shares). Shareholders of record in any Fund at October 12, 1990, and the members of their immediate family, 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. 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 .25 of 1% for Class B Shares and .75 of 1% for Class C Shares of each Fund's average daily net asset value. 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 B Shares and Class C Shares will be less than those payable to Trust Shares by the difference between distribution expenses borne by the shares of each respective class. [This Page Intentionally Left Blank] - ------------------------- 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, Transfer Agent, and Dividend Disbursing Agent State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- 3031007A-I (4/93) FIRST UNION EQUITY AND INCOME FUNDS (Portfolios of First Union Funds) Class B Investment Shares Class C Investment Shares - -------------------------------------------------------------------------------- Supplement to Prospectus dated February 28, 1994 Effective September 1, 1994, First Union Equity and Income Funds (the "Funds"), with the exception of First Union Managed Bond Fund, will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. A. Please delete the "Summary of Fund Expenses" table on pages 4 and 5 and replace it with the following: - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION EQUITY AND INCOME FUNDS CLASS B SHARES
Fixed High Grade U.S. Balanced Income Tax Free Government Utility Value Fund Fund Fund Fund Fund Fund Class B 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 B Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (1)....... 0.50% 0.50% 0.49% 0.49% 0.00% 0.50% 12b-1 Fees (2).......................... 0.25% 0.10% 0.25% 0.25% 0.25% 0.25% Total Other Expenses (after waiver) (3). 0.16% 0.16% 0.32% 0.25% 0.92% 0.17% Total Class B Shares Operating Expenses (4)....................... 0.91% 0.76% 1.06% 0.99% 1.17% 0.92%
(1)The management fees of High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (2)The Class B Shares can pay up to 0.75% of Class B Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, Fixed Income Fund plans to limit the Class B Shares' 12b-1 payments to 0.10% of Class B Shares' average daily net assets. All other Funds listed above plan to limit the Class B Shares' 12b-1 payments to 0.25% of Class B Shares' average daily net assets. (3)Total Other Expenses for Utility Fund are estimated to be 1.66%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4)Total Class B Shares Operating Expenses for Utility Fund are estimated to be 2.41%, absent the voluntary waivers described above in notes 1 and 3. Fixed Income, High Grade Tax Free, U.S. Government and Value Funds' Total Class B Shares Annual Operating Expenses were 0.93%, 0.85%, 0.69% and 0.99%, respectively, for the year ended December 31, 1993. Total Class B Shares Operating Expenses for High Grade Tax Free Fund, absent the voluntary waiver of the management fee by the Adviser and waiver of the 12b-1 fee, were 1.07% for the year ended December 31, 1993. Total Class B Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser and the voluntary waiver of the administrative fee by the administrator, were 1.00% for the year ended December 31, 1993. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION EQUITY AND INCOME FUNDS CLASS B SHARES The Annual Class B Shares Operating Expenses in the table above, except for the Balanced and Utility Funds, are based on expenses expected during the fiscal year ending December 31, 1994. The total Class B Shares expected operating expenses for High Grade Tax Free and U.S. Government Funds would be 1.07% and 1.00%, respectively, absent the anticipated voluntary waivers described above in note 1. Fixed Income and Value Funds are no longer allocating certain expenses as incurred by each class. Utility Fund expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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 charges 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. The Funds charge no redemption fees for Class B Shares. Balanced Fund............................... $56 $75 $ 96 $154 Fixed Income Fund........................... $55 $71 $ 88 $137 High Grade Tax Free Fund.................... $58 $80 $103 $171 U.S. Government Fund........................ $57 $78 $100 $163 Utility Fund................................ $59 $83 N/A N/A Value Fund.................................. $56 $75 $ 96 $155
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 Utility Fund Class B Shares is based on estimated data for the fiscal year ending December 31, 1994. 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 Trust Shares, Class C Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. 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 5.00%. Class D 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%. Trust Shares, Class C Shares and Class D Shares bear no front-end sales charge. See "Other Classes of Shares." B. Please delete the "Summary of Fund Expenses" table on pages 6 and 7 and replace it with the following: - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION EQUITY AND INCOME FUNDS CLASS C SHARES
Fixed High Grade U.S. Balanced Income Tax Free Government Utility Fund Fund Fund Fund Fund ---------------- ---------------- ---------------- ---------------- ---------------- Class C Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)...... None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................... None None None None None Contingent Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable) (1)................. 5% during 5% during 5% during 5% during 5% during the first year, the first year, the first year, the first year, the first year, 4% during 4% during 4% during 4% during 4% during the second year, the second year, the second year, the second year, the second year, 3% during 3% during 3% during 3% during 3% during the third year, the third year, the third year, the third year, the third year, 3% during 3% during 3% during 3% during 3% during the fourth year, the fourth year, the fourth year, the fourth year, the fourth year, 2% during 2% during 2% during 2% during 2% during the fifth year, the fifth year, the fifth year, the fifth year, the fifth year, 1% during 1% during 1% during 1% during 1% during the sixth year, the sixth year, the sixth year, the sixth year, the sixth year, and 0% after and 0% after and 0% after and 0% after and 0% after the sixth year the sixth year the sixth year the sixth year the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable).... None None None None None Exchange Fee......................... None None None None None Annual Class C Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (2).... 0.50% 0.50% 0.49% 0.49% 0.00% 12b-1 Fees........................... 0.75% 0.75% 0.75% 0.75% 0.75% Total Other Expenses (after waiver) (3)................. 0.41% 0.41% 0.57% 0.50% 1.17% Shareholder Service Fee......... 0.25% Total Class C Shares Operating Expenses (4).. 1.66% 1.66% 1.81% 1.74% 1.92% Balanced Fund ---------------- Class C Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)...... None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................... None Contingent Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable) (1)................. 5% during the first year, 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, and 0% after the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable).... None Exchange Fee......................... None Annual Class C Shares Operating Expenses (As a percentage of average net assets) Management Fee (after waiver) (2).... 0.50% 12b-1 Fees........................... 0.75% Total Other Expenses (after waiver) (3)................. 0.42% Shareholder Service Fee......... Total Class C Shares Operating Expenses (4).. 1.67%
(1)No contingent deferred sales charge is imposed on (a) Shares purchased more than six 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 High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (3)Total Other Expenses for Utility Fund are estimated to be 1.91%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4)Total Class C Shares Operating Expenses for Utility Fund are estimated to be 3.16%, absent the voluntary waivers described above in notes 2 and 3. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION EQUITY AND INCOME FUNDS CLASS C SHARES Fixed Income, High Grade Tax Free, U.S. Government and Value Funds' Total Class C Shares Annual Operating Expenses were 1.57%, 1.35%, 1.19% and 1.48%, respectively, for the year ended December 31, 1993. Total Class C Shares Operating Expenses for High Grade Tax Free Fund absent the voluntary waiver of the management fee by the Adviser and the waiver of the 12b-1 fee were 1.57% for the year ended December 31, 1993. Total Class C Shares Operating Expenses for U.S. Government Fund, absent the voluntary waiver of the management fee by the Adviser and the voluntary waiver of the administrative fee by the administrator, were 1.50% for the year ended December 31, 1993. The Annual Class C Shares Operating Expenses in the table above, except for Balanced and Utility Funds, are based on expenses expected during the fiscal year ending December 31, 1994. The total Class C Shares expected operating expenses, for High Grade Tax Free and U.S. Government Funds, would be 1.82% and 1.75%, respectively, absent the voluntary waivers described above in note 2. Fixed Income and Value Funds are no longer allocating certain expenses incurred by each class. Utility Fund expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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 charges 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. Balanced Fund............................... $69 $85 $114 $197 Fixed Income Fund........................... $69 $85 $114 $197 High Grade Tax Free Fund.................... $70 $90 $121 $213 U.S. Government Fund........................ $69 $88 $118 $205 Utility Fund................................ $71 $93 N/A N/A Value Fund.................................. $69 $86 $114 $198 You would pay the following expenses on the same investment, assuming no redemptions: Balanced Fund............................... $17 $52 $90 $197 Fixed Income Fund........................... $17 $52 $90 $197 High Grade Tax Free Fund.................... $18 $57 $98 $213 U.S. Government Fund........................ $18 $55 $94 $205 Utility Fund................................ $20 $60 N/A N/A Value Fund.................................. $17 $53 $91 $198
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 Utility Fund Class C Shares is based on estimated data for the fiscal year ending December 31, 1994. 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 Trust Shares, Class B Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales charge of 4.75%. Class D 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." C. Please insert the following "Summary of Fund Expenses" table on pages 8 and 9 for Class D Shares: - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION EQUITY AND INCOME FUNDS CLASS D SHARES
Fixed High Grade U.S. Balanced Income Tax Free Government Utility Value Fund Fund Fund Fund Fund Fund Class D Shares --------------- --------------- --------------- --------------- --------------- --------------- Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)...................... None None None None None None 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) (1)............... 1% during 1% during 1% during 1% during 1% during 1% during the first year, the first year, the first year, the first year, the first year, the first year, and 0% after and 0% after and 0% after and 0% after and 0% after and 0% after the first year the first year the first year the first year the first year the first year Redemption Fees (as a percentage of amount redeemed, if applicable).................... None None None None None None Exchange Fee.................... None None None None None None Annual Class D Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)........................... 0.50% 0.50% 0.49% 0.49% 0.00% 0.50% 12b-1 Fees...................... 0.75% 0.75% 0.75% 0.75% 0.75% 0.75% Total Other Expenses (after waiver) (3)................... 0.41% 0.41% 0.57% 0.50% 1.17% 0.42% Shareholder Service Fee.... 0.25% Total Class D Shares Operating Expenses (4). 1.66% 1.66% 1.81% 1.74% 1.92% 1.67%
(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 estimated management fees of High Grade Tax Free, U.S. Government and Utility Funds have been reduced to reflect the anticipated voluntary waiver by the Adviser. The Adviser may terminate these voluntary waivers at any time at its sole discretion. The maximum management fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (3)Total Other Expenses for Utility Fund are estimated to be 1.91%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4)Total Class D Shares Operating Expenses for High Grade Tax Free, U.S. Government and Utility Funds are estimated to be 1.82%, 1.75% and 3.16%, respectively, absent the anticipated voluntary waivers 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, 1994. 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. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION EQUITY AND INCOME FUNDS CLASS D SHARES Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charge 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. Balanced Fund................................................ $27 $52 Fixed Income Fund............................................ $27 $52 High Grade Tax Free Fund..................................... $29 $57 U.S. Government Fund......................................... $28 $55 Utility Fund................................................. $30 $60 Value Fund................................................... $27 $53 You would pay the following expenses on the same investment, assuming no redemptions: Balanced Fund................................................ $17 $52 Fixed Income Fund............................................ $17 $52 High Grade Tax Free Fund..................................... $18 $57 U.S. Government Fund......................................... $18 $55 Utility Fund................................................. $20 $60 Value Fund................................................... $17 $53
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, 1994. The information set forth in the foregoing table and example relates only to Class D Shares of the Funds. The Funds also offer three additional classes of shares called Trust Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales charge 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%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales charge. See "Other Classes of Shares." D. Please delete the first table (for Class B Investment Shares) under the section entitled "What Shares Cost" on page 28 and replace it with the following:
Sales Charge as a Percentage of Sales Charge as a Amount of Public Offering Percentage of Net Transaction Price Amount Invested ----------- --------------- ----------------- $0-99,999 4.75% 4.25% $100,000-249,999 3.75% 3.25% $250,000-499,999 3.00% 2.50% $500,000-1,000,000 2.00% 1.75% $1,000,000-2,500,000 1.00% 1.00% $2,500,000 and above 0.25% 0.25%
E. Please delete the second table (for Class C Investment Shares) under the section entitled "What Shares Cost" on page 28 and replace it with the following:
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%
September 1, 1994 FEDERATED SECURITIES CORP. - -------------------------------------------------------------------------------- Distributor G00389-14-B (9/94) P R O S P E C T U S FIRST UNION EQUITY AND INCOME FUNDS CLASS B AND C INVESTMENT SHARES FEBRUARY 28, 1994 [LOGO] FIRST UNION FUNDS FORMERLY THE SALEM FUNDS - ------------------------ FIRST UNION ------------------------ EQUITY AND INCOME - ------------------------ FUNDS ------------------------ Portfolios of First Union Funds CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1994 First Union Funds (the "Trust") is a mutual fund with 15 portfolios, offering a variety of investment opportunities. The Trust currently includes seven diversified Equity and Income Funds, three diversified Money Market Funds, and five non-diversified Single State Municipal Bond Funds. They are: Equity and Income Funds .First Union Balanced Portfolio; .First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio (Investment Shares not currently offered); . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and .First Union Value Portfolio. Money Market Funds .First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and .First Union Treasury Money Market Portfolio. Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. This prospectus provides you with information specific to the Class B Investment Shares ("Class B Shares") and Class C Investment Shares ("Class C Shares") of First Union Equity and Income Funds. It concisely describes the information which you should know before investing in Class B Shares or Class C Shares of any of the First Union Equity and Income Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Equity and Income Fund in its Statement of Additional Information dated February 28, 1994, 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 value of investment company shares offered by this prospectus fluctuates daily. 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 "FIRST UNION HIGH GRADE TAX FREE PORTFOLIO--MUNICIPAL BOND INSURANCE," PAGE 19. - -------------------------------------------------------------------------------- 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 - -------------------------------------- SUMMARY OF FUND EXPENSES 4 - -------------------------------------- FINANCIAL HIGHLIGHTS 8 - -------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 16 - -------------------------------------- FIRST UNION BALANCED PORTFOLIO 16 - -------------------------------------- FIRST UNION FIXED INCOME PORTFOLIO 17 - -------------------------------------- FIRST UNION HIGH GRADE TAX FREE PORTFOLIO 18 - -------------------------------------- FIRST UNION U.S. GOVERNMENT PORTFOLIO 20 - -------------------------------------- FIRST UNION UTILITY PORTFOLIO 21 - -------------------------------------- FIRST UNION VALUE PORTFOLIO 22 - -------------------------------------- OTHER INVESTMENT POLICIES 23 - -------------------------------------- SHAREHOLDER GUIDE 26 - -------------------------------------- HOW TO BUY SHARES 28 - -------------------------------------- HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND 30 - -------------------------------------- HOW TO REDEEM SHARES 30 - -------------------------------------- ADDITIONAL SHAREHOLDER SERVICES 31 - -------------------------------------- MANAGEMENT OF FIRST UNION FUNDS 31 - -------------------------------------- FEES AND EXPENSES 33 - -------------------------------------- SHAREHOLDER RIGHTS AND PRIVILEGES 34 - -------------------------------------- DISTRIBUTIONS AND TAXES 35 - -------------------------------------- TAX INFORMATION 35 - -------------------------------------- OTHER CLASSES OF SHARES 36 - -------------------------------------- ADDRESSES Inside Back Cover - -------------------------------------- - ------------------------- 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 15 portfolios, each representing a different First Union Fund. Each Equity and Income Fund, except First Union Managed Bond Portfolio, is divided into three classes of shares: Class B Shares, Class C Shares, and Trust Shares. Class B 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 B Shares), or (ii) on a contingent deferred basis (the Class C Shares). Trust Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). First Union Managed Bond Portfolio presently offers only Trust Shares. This prospectus relates to both classes of Investment Shares ("Shares") of First Union Equity and Income Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Class B and Class C Shares are offered in the following six Funds: . FIRST UNION BALANCED PORTFOLIO ("BALANCED FUND")--seeks to produce long-term total return through capital appreciation, dividends, and interest income; . 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 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; . FIRST UNION U.S. GOVERNMENT PORTFOLIO ("U.S. GOVERNMENT FUND")--seeks a high level of current income consistent with stability of principal; . 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 Class B and Class C 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 several of the Funds described in this prospectus, may vary inversely in response to changes in prevailing interest rates. The foreign securities in which several 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 EQUITY AND INCOME FUNDS CLASS B SHARES
Fixed High Grade U.S. Balanced Income Tax Free Government Utility Value Fund Fund Fund Fund Fund Fund -------- ------ ---------- ---------- ------- ----- CLASS B SHARES SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offer- ing price)................ 4.00% 4.00% 4.00% 4.00% 4.00% 4.00% Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offer- ing price)................ None None None None None None Deferred Sales Load (as a percentage of original purchase price or redemp- tion proceeds, as applica- ble)...................... None None None None None None Redemption Fee (as a per- centage of amount re- deemed, if applicable)............ None None None None None None Exchange Fee............... None None None None None None ANNUAL CLASS B SHARES OPERATING EXPENSES (As a percentage of average net assets) Management Fee (after waiver) (1)............... 0.50% 0.50% 0.49% 0.49% 0.00% 0.50% 12b-1 Fees (2)............. 0.25% 0.10% 0.25% 0.25% 0.25% 0.25% Total Other Expenses (after waiver) (3)............... 0.16% 0.16% 0.32% 0.25% 0.92% 0.17% Total Class B Shares Op- erating Expenses (4)...... 0.91% 0.76% 1.06% 0.99% 1.17% 0.92%
(1) The management fees of High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (2) The Class B Shares can pay up to 0.75% of Class B Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, Fixed Income Fund plans to limit the Class B Shares' 12b-1 payments to 0.10% of Class B Shares' average daily net assets. All other Funds listed above plan to limit the Class B Shares' 12b-1 payments to 0.25% of Class B Shares' average daily net assets. (3) Total Other Expenses for Utility Fund are estimated to be 1.66%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4) Total Class B Shares Operating Expenses for Utility Fund are estimated to be 2.41%, absent the voluntary waivers described above in notes 1 and 3. Fixed Income, High Grade Tax Free, U.S. Government and Value Funds' Total Class B Shares Annual Operating Expenses were 0.93%, 0.85%, 0.69% and 0.99%, respectively, for the year ended December 31, 1993. Total Class B Shares Operating Expenses for High Grade Tax Free Fund absent the voluntary waiver of the management fee by the Adviser and waiver of the 12b-1 fee was 1.07% for the year ended December 31, 1993. Total Class B Shares Operating Expenses for U.S. Government Fund absent the voluntary waiver of the management fee by the Adviser and the voluntary waiver of the administrative fee by the administrator, was 1.00% for the year ended December 31, 1993. The Annual Class B Shares Operating Expenses in the table above, except for the Balanced and Utility Funds, are based on expenses expected during the fiscal year ending December 31, 1994. The total Class B Shares expected operating expenses for High Grade Tax Free and U.S. Government Funds would be 1.07% and 1.00%, respectively, absent the voluntary waivers described above in note 1. Fixed Income and Value Funds are no longer allocating certain expenses as incurred by each class. Utility Fund expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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 charges 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. The Funds charge no redemption fees for Class B Shares. Balanced Fund............................... $49 $68 $88 $147 Fixed Income Fund........................... $47 $63 $81 $130 High Grade Tax Free Fund.................... $50 $72 $96 $164 U.S. Government Fund........................ $50 $70 $93 $156 Utility Fund................................ $51 $76 NA NA Value Fund.................................. $49 $68 $89 $149
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 UTILITY FUND CLASS B SHARES IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. 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 Trust Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales load or 12b-1 fee. Class C Shares are subject to a 12b-1 fee of 0.75 of 1% and bear a maximum contingent deferred sales load of 4.00%. Neither Trust Shares nor Class C Shares bear a front-end sales load. See "Other Classes of Shares." - ------------------------ SUMMARY OF ------------------------ - ------------------------ FUND EXPENSES ------------------------ FIRST UNION EQUITY AND INCOME FUNDS CLASS C SHARES
Fixed High Grade U.S. Balanced Income Tax Free Government Utility Fund Fund Fund Fund Fund ---------------- ---------------- ---------------- ---------------- ---------------- CLASS C SHARES SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Pur- chases (as a percentage of offering price). None None None None None Maximum Sales Load Imposed on Re- invested Dividends (as a percentage of offering price). None None None None None Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable) (1).... 4% during 4% during 4% during 4% during 4% during the first year, the first year, the first year, the first year, the first year, 3% during 3% during 3% during 3% during 3% during the second year, the second year, the second year, the second year, the second year, 2.5% during 2.5% during 2.5% during 2.5% during 2.5% during the third year, the third year, the third year, the third year, the third year, 2% during 2% during 2% during 2% during 2% during the fourth year, the fourth year, the fourth year, the fourth year, the fourth year, 1.5% during 1.5% during 1.5% during 1.5% during 1.5% during the fifth year, the fifth year, the fifth year, the fifth year, the fifth year, 0.5% during 0.5% during 0.5% during 0.5% during 0.5% during the sixth year, the sixth year, the sixth year, the sixth year, the sixth year, and 0% after and 0% after and 0% after and 0% after and 0% after the sixth year the sixth year the sixth year the sixth year the sixth year Redemption Fee (as a per- centage of amount redeemed, if applicable). None None None None None Exchange Fee.... None None None None None Value Fund ----------------- CLASS C SHARES SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offering price)... None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price). None Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable)(1).... 4% during the first year, 3% during the second year, 2.5% during the third year, 2% during the fourth year, 1.5% during the fifth year, 0.5% during the sixth year, and 0% after the sixth year Redemption Fee (as a per- centage of amount redeemed, if applicable). None Exchange Fee.... None ANNUAL CLASS C SHARES OPERATING EXPENSES (As a percentage of average net assets) Management Fee (after waiver) (2).... 0.50% 0.50% 0.49% 0.49% 0.00% 12b-1 Fees... 0.75% 0.75% 0.75% 0.75% 0.75% Total Other Expenses (after waiver) (3).... 0.16% 0.16% 0.32% 0.25% 0.92% Total Class C Shares Operating Expenses (4). 1.41% 1.41% 1.56% 1.49% 1.67% ANNUAL CLASS C SHARES OPERATING EXPENSES (As a percentage of average net assets) Management Fee (after waiver) (2).... 0.50% 12b-1 Fees... 0.75% Total Other Expenses (after waiver) (3).... 0.17% Total Class C Shares Operating Expenses (4). 1.42%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than six 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 High Grade Tax Free, U.S. Government and Utility 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 fee for High Grade Tax Free, U.S. Government and Utility Funds is 0.50%. (3) Total Other Expenses for Utility Fund are estimated to be 1.66%, absent the anticipated voluntary waiver by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4) Total Class C Shares Operating Expenses for Utility Fund are estimated to be 2.91%, absent the voluntary waivers described above in notes 2 and 3. Fixed Income, High Grade Tax Free, U.S. Government and Value Funds' Total Class C Shares Annual Operating Expenses were 1.57%, 1.35%, 1.19% and 1.48%, respectively, for the year ended December 31, 1993. Total Class C Shares Operating Expenses for High Grade Tax Free absent the voluntary waiver of the management fee by the Adviser and the waiver of the 12b-1 fee was 1.57% for the year ended December 31, 1993. Total Class C Shares Operating Expenses for U.S. Government Fund absent the voluntary waiver of the management fee by the Adviser and the voluntary waiver of the administrative fee by the administrator was 1.50% for the year ended December 31, 1993. The Annual Class C Shares Operating Expenses in the table above, except for Balanced and Utility Funds, are based on expenses expected during the fiscal year ending December 31, 1994. The total Class C Shares expected operating expenses, for High Grade Tax Free and U.S. Government Funds, would be 1.57% and 1.50%, respectively, absent the voluntary waivers described above in note 2. Fixed Income and Value Funds are no longer allocating certain expenses as incurred by each class. Utility Fund expenses in this table are estimated based on average expenses expected to be incurred during the fiscal year ending December 31, 1994. 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 charges 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: Balanced Fund...................................................................... $56 $72 $95 $169 Fixed Income Fund.................................................................. $56 $72 $95 $169 High Grade Tax Free Fund........................................................... $57 $77 $103 $186 U.S. Government Fund............................................................... $57 $75 $99 $178 Utility Fund....................................................................... $58 $80 NA NA Value Fund......................................................................... $56 $73 $96 $170 You would pay the following expenses on the same investment, assuming no redemptions: Balanced Fund...................................................................... $14 $45 $77 $169 Fixed Income Fund.................................................................. $14 $45 $77 $169 High Grade Tax Free Fund........................................................... $16 $49 $85 $186 U.S. Government Fund............................................................... $15 $47 $81 $178 Utility Fund....................................................................... $17 $53 NA NA Value Fund......................................................................... $14 $45 $78 $170
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 UTILITY FUND CLASS C SHARES IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. The information set forth in the foregoing table and example relates only to Class C Shares of the Funds. The Funds also offer two additional classes of shares called Trust Shares and Class B Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales load or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1%and bear a maximum sales load of 4.00%. See "Other Classes of Shares." - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ FIRST UNION BALANCED PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS C TRUST SHARES CLASS B INVESTMENT SHARES INVESTMENT SHARES -------------------------------- ---------------------------------- ----------------- YEAR ENDED YEAR ENDED YEAR ENDED -------------------------------- ---------------------------------- ----------------- 12/31/93 12/31/92 12/31/91** 12/31/93 12/31/92 12/31/91*** 12/31/93+ - ------------------------ --------- --------- ---------- -------- -------- ----------- ----------------- NET ASSET VALUE, BEGIN- NING OF PERIOD $ 11.41 $ 11.02 $ 10.00 $ 11.41 $ 11.02 $ 10.00 $ 11.54 - ------------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------------ Net investment income 0.45 0.46 0.36 0.419 0.42 0.30 0.34 - ------------------------ Net realized and unrealized gain (loss) on investments 0.75 0.42 1.03 0.755 0.43 1.08 0.65 - ------------------------ ------ ------ ------ ------ ------ ------- ------ Total from investment operations 1.20 0.88 1.39 1.174 0.85 1.38 0.99 - ------------------------ ------ ------ ------ ------ ------ ------- ------ LESS DISTRIBUTION - ------------------------ Dividends to shareholders from net investment income (0.45) (0.45) (0.36) (0.419) (0.42) (0.35) (0.34) - ------------------------ Distributions to shareholders from net realized gain on investment transactions (0.09) (0.04) (0.01) (0.091) (0.04) (0.01) (0.09) - ------------------------ Distributions in excess of net investment income -- -- -- (0.004)(b) -- -- (0.02)(b) - ------------------------ ------ ------ ------ ------ ------ ------ ------- Total distributions (0.54) (0.49) (0.37) (0.514) (0.46) (0.36) (0.45) - ------------------------ ------- ------- ------- -------- ------- ------- ------- NET ASSET VALUE, END OF PERIOD $12.07 $11.41 $11.02 $12.07 $11.41 $11.02 $12.08 - ------------------------ ------ ------ ------ ------ ------ ------- ------ TOTAL RETURN* 10.68% 8.21% 15.02% 10.41% 7.94% 11.75% 8.72% - ------------------------ RATIOS TO AVERAGE NET ASSETS - ------------------------ Expenses 0.66% 0.66% 0.68%(a) 0.91% 0.91% 0.92%(a) 1.41%(a) - ------------------------ Net investment income 3.86% 4.20% 4.86%(a) 3.61% 3.93% 4.38%(a) 3.09%(a) - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of pe- riod (000 omitted) $760,147 $520,232 $247,472 $35,032 $17,408 $334 $65,475 - ------------------------ Portfolio turnover rate 19% 12% 19% 19% 12% 19% 19% - ------------------------
* Based on net asset value, which does not reflect the sales load or contin- gent deferred sales charge, if applicable. ** Reflects operations for the period from April 1, 1991 (commencement of op- erations) to December 31, 1991. *** Reflects operations for the period from June 10, 1991 (commencement of op- erations) to December 31, 1991. + Reflects operations for the period from January 26, 1993 (commencement of operations) to December 31, 1993. (a) Computed on an annualized basis. (b) Distributions in excess of net investment income for the year ended De- cember 31, 1993, were the result of certain book and tax timing differ- ences. These distributions do not represent a return of capital for fed- eral income tax purposes. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ FIRST UNION FIXED INCOME PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES CLASS B INVESTMENT SHARES --------------------------- ----------------------------------------------------------- PERIOD ENDED PERIOD ENDED --------------------------- ----------------------------------------------------------- 12/31/93 12/31/92 12/31/91* 12/31/93 12/31/92 12/31/91 12/31/90+ 3/31/90 3/31/89++ - ---------------- -------- -------- --------- -------- -------- -------- --------- ------- --------- NET ASSET VALUE, BEGINNING OF PERIOD $10.41 $10.54 $10.06 $10.41 $10.54 $ 9.99 $9.72 $9.50 $9.70 - ---------------- INCOME FROM IN- VESTMENT OPERA- TIONS - ---------------- Net investment income 0.69 0.70 0.71 0.65 0.71 0.73 0.55 0.79 0.10 - ---------------- Net realized and unrealized gain (loss) on investments 0.19 (0.02) 0.56 0.19 (0.06) 0.60 0.24 0.20 (0.14) - ---------------- ------ ------ ------ ------ ------ ------ ----- ----- ----- Total from investment operations 0.88 0.68 1.27 0.84 0.65 1.33 0.79 0.99 (0.04) - ---------------- ------ ------ ------ ------ ------ ------ ----- ----- ----- LESS DISTRIBU- TIONS - ---------------- Dividends to shareholders from net investment income (0.68) (0.70) (0.71) (0.65) (0.67) (0.70) (0.52) (0.77) (0.16) - ---------------- Distributions to shareholders from net realized gain on investments (0.18) (0.11) (0.07) (0.18) (0.11) (0.07) -- -- -- - ---------------- Distributions in excess of net investment income -- -- (0.01)(a) -- -- (0.01)(a) -- -- -- - ---------------- ------ ------ ------ ------ ------ ------ ----- ----- ----- Total distribu- (0.86) (0.81) (0.79) (0.83) (0.78) (0.78) (0.52) (0.77) (0.16) tions ------ ------ ------ ------ ------ ------ ----- ----- ----- - ---------------- NET ASSET VALUE, END OF PERIOD $10.43 $10.41 $10.54 $10.42 $10.41 $10.54 $9.99 $9.72 $9.50 - ---------------- ------ ------ ------ ------ ------ ------ ----- ----- ----- TOTAL RETURN** 8.67% 6.64% 13.80% 8.29% 6.39% 13.74% 8.31% 10.51% (0.31)% - ---------------- RATIOS TO AVERAGE NET ASSETS - ---------------- Expenses 0.66% 0.69% 0.69%(c) 0.93% 0.90% 0.80% 1.01%(c) 1.00% 1.78%(c) - ---------------- Net investment income 6.41% 6.67% 7.12%(c) 6.15% 6.79% 7.30% 7.53%(c) 7.52% 6.10%(c) - ---------------- Expense waiver/ reimbursement (b) -- -- 0.07%(c) -- -- 0.09% 0.81%(c) 0.50% -- (c) - ---------------- SUPPLEMENTAL DATA - ---------------- Net assets, end of period (000 omitted) $376,445 $324,068 $256,254 $22,865 $21,488 $17,680 $11,765 $6,496 $11,580 - ---------------- Portfolio turnover rate 73% 66% 55% 73% 26% 66% 27% 32% 18% - ---------------- CLASS C INVESTMENT SHARES ------------- PERIOD ENDED ------------- 12/31/93+++ - ----------------- ------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.57 - ----------------- INCOME FROM IN- VESTMENT OPERA- TIONS - ----------------- Net investment income 0.58 - ----------------- Net realized and unrealized gain (loss) on investments 0.05 - ----------------- ------------- Total from investment operations 0.63 - ----------------- ------------- LESS DISTRIBU- TIONS - ----------------- Dividends to shareholders from net investment income (0.58) - ----------------- Distributions to shareholders from net realized gain on investments (0.18) - ----------------- Distributions in excess of net investment income -- - ----------------- ------------- Total distribu- tions (0.76) - ----------------- ------------- NET ASSET VALUE, END OF PERIOD $10.44 - ----------------- ------------- TOTAL RETURN** 6.08% - ----------------- RATIOS TO AVERAGE NET ASSETS - ----------------- Expenses 1.57%(c) - ----------------- Net investment income 5.42%(c) - ----------------- Expense waiver/ reimbursement (b) -- (c) - ----------------- SUPPLEMENTAL DATA - ----------------- Net assets, end of period (000 omitted) $8,876 - ----------------- Portfolio turnover rate 73% - -----------------
(Continued) - ------------------------ FINANCIAL ------------------------ - ------------------------ HIGHLIGHTS ------------------------ (CONTINUED) FIRST UNION FIXED INCOME PORTFOLIO * 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 sales load or contingent deferred sales charge, if applicable. + Nine months ended December 31, 1990. ++ Reflects operations for the period from January 28, 1989 (commencement of operations) to March 31, 1989. +++ Reflects operations for the period from January 26, 1993 (commencement of operations) to December 31, 1993. (a) 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 differences did not represent a return of capital for federal income tax purposes for the year ended December 31, 1991. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION HIGH GRADE TAX FREE PORTFOLIO (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS C INVESTMENT CLASS B INVESTMENT SHARES (C) SHARES (C) ------------------------------------ ------------------- YEAR ENDED PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993 DECEMBER 31, 1992* DECEMBER 31, 1993** - ------------------------ ----------------- ------------------ ------------------- NET ASSET VALUE, BEGIN- NING OF PERIOD $10.42 $10.00 $10.42 - ------------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------------ Net investment income 0.54 0.51 0.47 - ------------------------ Net realized and unrealized gain on in- vestments 0.81 0.42 0.81 - ------------------------ ------ ------ ------ Total from investment operations 1.35 0.93 1.28 - ------------------------ LESS DISTRIBUTIONS - ------------------------ Dividends to sharehold- ers from net investment income (0.54) (0.51) (0.47) - ------------------------ Distributions to share- holders from net real- ized gain on investment transactions (0.07) -- (0.07) - ------------------------ ------ ------ ------ Total distributions (0.61) (0.51) (0.54) - ------------------------ ------ ------ ------ NET ASSET VALUE, END OF $11.16 $10.42 $11.16 PERIOD ------ ------ ------ - ------------------------ TOTAL RETURN*** 13.25% 9.37% 12.41% - ------------------------ RATIOS TO AVERAGE NET ASSETS - ------------------------ Expenses 0.85% 0.49%(a) 1.35%(a) - ------------------------ Net investment income 4.99% 5.79%(a) 4.44%(a) - ------------------------ Expense waiver/reimbursement (b) 0.22% 0.62%(a) 0.22%(a) - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of period (000 omitted) $101,352 $90,738 $41,030 - ------------------------ Portfolio turnover rate 14% 7% 14% - ------------------------
* 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 contin- gent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such shares. The Financial High- lights presented above are historical information for Class B and Class C Investment Shares of the Fund. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION U.S. GOVERNMENT PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Fnancial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C TRUST INVESTMENT INVESTMENT SHARES SHARES SHARES --------- ---------- ---------- PERIOD PERIOD PERIOD ENDED ENDED ENDED 12/31/93* 12/31/93** 12/31/93** - ------------------------------------- --------- ---------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $10.25 $10.00 $10.00 - ------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ------------------------------------- Net investment income 0.25 0.68 0.63 - ------------------------------------- Net realized and unrealized gain (loss) on investments (0.20) 0.05 0.05 - ------------------------------------- ----- ---- ---- Total from investment operations 0.05 0.73 0.68 - ------------------------------------- LESS DISTRIBUTIONS - ------------------------------------- Dividends to shareholders from net investment income (0.25) (0.68) (0.63) - ------------------------------------- ----- ----- ----- NET ASSET VALUE, END OF PERIOD $10.05 $10.05 $10.05 - ------------------------------------- ------ ------ ------ TOTAL RETURN*** 0.49% 7.43% 6.91% - ------------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------------- Expenses 0.48%(a) 0.69%(a) 1.19%(a) - ------------------------------------- Net investment income 7.20%(a) 6.93%(a) 6.44%(a) - ------------------------------------- Expense adjustment (b) 0.31%(a) 0.31%(a) 0.31%(a) - ------------------------------------- SUPPLEMENTAL DATA - ------------------------------------- Net assets, end of period (000 omit- ted) $14,486 $38,851 236,696 - ------------------------------------- Portfolio turnover rate 39% 39% 39% - -------------------------------------
* 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. *** Based on net asset value, which does not reflect the sales load or contin- gent deferred sales charge, if applicable. (a) Computed on an annualized basis. (b) The voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION VALUE PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
TRUST SHARES -------------------------------- PERIOD ENDED -------------------------------- 12/31/93 12/31/92 12/31/91* - ------------------------------------------ --------- -------- --------- NET ASSET VALUE, BEGINNING OF PERIOD $17.11 $17.08 $14.28 - ------------------------------------------ INCOME FROM INVESTMENT OPERATIONS - ------------------------------------------ Net investment income 0.52 0.49 0.47 - ------------------------------------------ Net realized and unrealized gain (loss) on investments 1.12 0.90 3.53 - ------------------------------------------ ---- ---- ---- Total from investment operations 1.64 1.39 4.00 - ------------------------------------------ ---- ---- ---- LESS DISTRIBUTIONS - ------------------------------------------ Dividends to shareholders from net in- vestment income (0.52) (0.49) (0.47) - ------------------------------------------ Distributions to shareholders form net realized gain on investment transactions (0.58) (0.87) (0.73) - ------------------------------------------ Distributions in excess of net investment income (0.02)(c) -- -- - ------------------------------------------ ------ ------- ------- Total distributions (1.12) (1.36) (1.20) - ------------------------------------------ ------- ------- ------- NET ASSET VALUE, END OF PERIOD $17.63 $17.11 $17.08 - ------------------------------------------ ------ ------ ------ TOTAL RETURN** 9.71% 8.31% 25.41% - ------------------------------------------ RATIOS TO AVERAGE NET ASSETS - ------------------------------------------ Expenses 0.65% 0.68% 0.69%(b) - ------------------------------------------ Net investment income 2.98% 2.90% 3.04%(b) - ------------------------------------------ Expense waiver/reimbursement (a) -- 0.01% 0.08%(b) - ------------------------------------------ SUPPLEMENTAL DATA - ------------------------------------------ Net assets, end of period $463,087 $326,154 $271,391 - ------------------------------------------ Portfolio turnover rate 46% 56% 69% - ------------------------------------------
* 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 contin- gent 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. (c) Distributions in excess of net investment income for the period ended De- cember 31, 1993, were the result of certain book and tax filing differ- ences. These distributions do not represent a return of capital for federal income tax purposes. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- FIRST UNION VALUE PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT EACH PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B INVESTMENT SHARES ---------------------------------------------------------------------------------------------------- PERIOD ENDED ---------------------------------------------------------------------------------------------------- 12/31/93 12/31/92 12/31/91 12/31/90** 3/31/90 3/31/89 3/31/88 3/31/87 3/31/86 3/31/85*** - ------------------------ -------- -------- -------- ---------- ------- ------- ------- ------- ------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $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 0.47 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 1.10 0.89 3.17 (0.44) 1.70 2.11 (1.30) 2.38 2.32 0.00 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ Total from investment operations 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 (0.47) (0.43) (0.43) (0.36) (0.57) (0.38) (0.26) (0.13) (0.20) (0.00) - ------------------------ Distribution to shareholders from net realized gain on investments (0.58) (0.87) (0.73) (0.02) (1.00) (0.47) (0.53) (0.09) (0.00) (0.00) - ------------------------ Distributions in excess of net investment -- -- -- (0.05)(a) -- -- -- -- -- -- income ------ ------ ------ ------- ------ ------- ------ ------- ------ ------ - ------------------------ Total distributions (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 $17.63 $17.11 $17.08 $14.61 $15.12 $14.45 $12.83 $14.66 $12.35 $10.04 - ------------------------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------ TOTAL RETURN* 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 0.99% 1.01% 0.96% 1.39%(b) 1.55% 1.71% 1.74% 1.97% 2.00% 2.00%(b) - ------------------------ Net investment income 2.63% 2.57% 2.78% 3.28%(b) 3.42% 2.72% 1.92% 1.41% 2.34% 6.47%(b) - ------------------------ Expense waiver/ adjustment (d) -- 0.01% 0.09% -- -- -- -- -- -- -- - ------------------------ SUPPLEMENTAL DATA - ------------------------ Net assets, end of period $189,983 $169,310 $135,565 $104,637 $95,995 $83,121 $21,914 $23,221 $5,595 $100 - ------------------------ Portfolio turnover rate**** 46% 56% 69% 13% 11% 24% 16% 20% 20% 0% - ------------------------
(See notes on page 15.) (Continued) - ------------------------- FINANCIAL ------------------------- - ------------------------- HIGHLIGHTS ------------------------- (CONTINUED) FIRST UNION VALUE PORTFOLIO
CLASS C INVESTMENT SHARES ---------- PERIOD ENDED ---------- 12/31/93+ - ------------------------------- ---------- NET ASSET VALUE, BEGINNING OF PERIOD $17.24 - ------------------------------- INCOME FROM INVESTMENT OPERA- TIONS - ------------------------------- Net investment income 0.35 - ------------------------------- Net realized and unrealized gain (loss) on investments 1.01 - ------------------------------- ------ Total from investment operations 1.36 - ------------------------------- ------ LESS DISTRIBUTIONS - ------------------------------- Dividends to shareholders from net investment income (0.35) - ------------------------------- Distribution to shareholders from net realized gain on in- vestments (0.58) - ------------------------------- Distributions in excess of net investment income (0.04)(c) - ------------------------------- ------- Total distributions (0.97) - ------------------------------- ------ NET ASSET VALUE, END OF PERIOD $17.63 - ------------------------------- ------ TOTAL RETURN* 7.98% - ------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------- Expenses 1.48%(b) - ------------------------------- Net investment income 2.09%(b) - ------------------------------- Expense waiver/reimbursement (d) -- - ------------------------------- SUPPLEMENTAL DATA - ------------------------------- Net assets, end of period $59,953 - ------------------------------- Portfolio turnover rate**** 46% - -------------------------------
* Based on net asset value, which does not reflect the sales load or contin- gent deferred sales charge, if applicable. **For the nine months ended December 31, 1990. *** Reflects operations for the period from August 30, 1984 (commencement of operations) to March 31, 1985. **** Portfolio turnover rate for periods ending on or after March 31, 1986 include certain U.S. government obligations. + Reflects operations for the period from February 2, 1993 (commencement of operations) to December 31, 1993. (a) Distributions in excess of net investment income for the period ended De- cember 31, 1990, were a result of certain book and tax timing differ- ences. These distributions did not represent a return of capital for fed- eral income tax purposes for the year ended December 31, 1990. (b)Computed on an annualized basis. (c) Distributions in excess of net investment income for the period ended De- cember 31, 1993, were the result of certain book and tax timing differ- ences. These distributions do not represent a return of capital for fed- eral income tax purposes. (d) This voluntary expense decrease is reflected in both the expense and net investment income ratios shown above. FURTHER INFORMATION ABOUT THE FUND'S PERFORMANCE IS CONTAINED IN THE TRUST'S ANNUAL REPORT, DATED DECEMBER 31, 1993, WHICH CAN BE OBTAINED FREE OF CHARGE. - ------------------------- INVESTMENT ------------------------- OBJECTIVES - ------------------------- AND POLICIES ------------------------- First Union Equity 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 investment grade 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, 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 Corporation ("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 Federal Home Loan Banks, Federal National Mortgage Association, Government National Mortgage Association, Banks for Cooperatives, Federal Farm Credit Banks, Tennessee Valley Authority, Export-Import Bank of the United States, Commodity Credit Corporation, Federal Financing Bank, Student Loan Marketing Association, Federal Home Loan Mortgage Corporation, or 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 ------------------------- 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 The Fund will only invest its assets in 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 or stripped bonds, debentures, notes, U.S. government securities, and debt securities convertible into, or exchangeable for, preferred or common stock. Stated final maturity for these securities may range up to 30 years. The duration of the securities will not exceed ten years. The Fund intends to maintain a dollar-weighted average maturity of five 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, as described under the caption "First Union Balanced Portfolio--Types of Investments"; and (5) repurchase agreements collateralized by any security listed above. 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 - ------------------------- HIGH GRADE TAX FREE ------------------------- - ------------------------- PORTFOLIO ------------------------- (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) Objective: High level of federally tax free income that is consistent with preservation of capital. Invests in: Insured municipal bonds. Suitable for: Investors seeking high tax-free monthly income and greater liquidity. Key Benefit: Greater diversification and liquidity than purchasing municipal bonds directly. Pays monthly dividends for those who need current income. DESCRIPTION OF THE FUND The High Grade Tax Free Fund seeks a high level of federally tax free income that is consistent with preservation of capital. The Fund pursues this objective by investing primarily in a portfolio of insured municipal bonds. At least 65% of the value of its total assets will be invested in insured obligations. The insurance guarantees the timely payment of principal and interest but not the value of the municipal bonds or shares of the Fund. As a matter of investment policy, which cannot be changed without the approval of shareholders, the Fund 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 income 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 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 the Fund in calculating the federal individual alternative minimum tax or the federal alternative minimum tax for corporations. The municipal bonds in which the Fund may invest are subject to the following quality standards: rated A or better by Moody's or S&P, or, if unrated, determined by the Adviser to be of comparable quality to such rated bonds; or, insured by a municipal bond insurance company which is rated Aaa by Moody's or AAA by S&P. A description of the rating categories is contained in the Appendix of the Fund's Statement of Additional Information. TEMPORARY INVESTMENTS 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 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; 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 acceptable investments of the Fund. Although the Fund is permitted to make taxable, temporary investments, there is no current intention of generating income subject to federal income tax. The Fund may also purchase investments 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 (lender) 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 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 bonds 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 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. The purpose of municipal bond insurance is to guarantee the timely payment of principal at maturity and interest. MUNICIPAL BOND INSURANCE At least 65% of the Fund's total assets will be invested in municipal securities which are insured for timely payment of principal at maturity and interest. The Fund will require insurance when purchasing municipal securities which would not otherwise meet the Fund's quality standards. The 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. Securities in the 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 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 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 insurance policies reduce the yield to shareholders. 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 issued or guaranteed by the U.S. government, its agencies or instrumentalities ("U.S. government securities"). 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 The Fund may invest in: U.S. government securities. These include: (1) securities which are backed by the full faith and credit of the U.S. government (for example, U.S. Treasury bills, notes, and bonds); (2) obligations issued or guaranteed by U.S. government agencies and instrumentalities, which are supported by any of the following: (a) the full faith and credit of the U.S. government (such as participation certificates guaranteed by Government National Mortgage Association or Federal Housing Administration debentures), (b) the right of the issuer to borrow an amount limited to a specific line of credit from the U.S. government (for example, obligations of Federal Home Loan Banks); (c) discretionary authority of the U.S. government to purchase the issuer's obligations (for example, obligations of the Federal National Mortgage Association); (d) the credit of the instrumentality or agency issuing the obligations (for example, obligations of the Tennessee Valley Authority, the Bank for Cooperatives and the Federal Home Loan Mortgage Corporation); Securities representing ownership interest in mortgage pools ("mortgage- backed securities"). The yield and maturity characteristics of these 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 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; 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 in cash and cash items including such short-term obligations as: commercial paper; obligations issued 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 securities of utility companies. 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. 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; commercial paper, including master demand notes; 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."); ADRs of foreign companies traded on the New York or American Stock Exchanges or in the over-the-counter market; 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; 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, and 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; 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 (for up to 5% of its net assets); zero coupon bonds issued or guaranteed by the U.S. government, its agencies or instrumentalities (for 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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), 15% (in the case of the Fixed Income, High Grade Tax Free, and Utility Funds) or one-third (in the case of the U.S. Government Fund) of the value of their total assets. FOREIGN INVESTMENTS The Balanced, Fixed Income, Utility and Value Funds 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 U.S. Government Fund 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 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 U.S. Government Fund receives 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 collateralized mortgage obligations, 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 U.S. Government Fund 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 U.S. Government Fund 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. OPTIONS AND FUTURES All of 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, interest rate or exchange rate risk. The Funds do not use these transactions for speculation or leverage. Options and futures may be volatile investments and involve certain risks which might result in lowering the Funds' returns. The three principal areas of risk include: (1) lack of a liquid secondary market for a futures or option contract when the Fund wants to close out its position; (2) imperfect correlation of changes in the prices of futures or options contracts with the prices of the securities in the Fund's portfolio; and (3) incorrect forecasts by the Adviser of interest rates, market values or other economic factors. In these events, the Fund may lose money on the futures contract or option. 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 10% (in the case of Value Fund), 15% (in the case of the Balanced, Fixed Income, High Grade Tax Free, and Utility 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. Balanced, Fixed Income, High Grade Tax Free, and Value Funds may invest up to 10% of their net assets in illiquid securities. U.S. Government and Utility Funds may invest up to 15% of their net assets in illiquid securities. With respect to the Balanced, Fixed Income, U.S. Government, 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 High Grade Tax Free and Value Funds, illiquid securities include repurchase agreements providing for settlement in more than seven days after notice and certain restricted securities. 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 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. "NON-ACTIVE" SECURITIES The Fixed Income, High Grade Tax Free, and Value Funds will not invest more than 10% of their net assets in securities for which an active and substantial market does not exist, along with investments in illiquid securities, restricted securities, securities for which market quotations are not readily available, and repurchase agreements maturing in more than seven days. WARRANTS The Balanced, Fixed Income, High Grade Tax Free, 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 ------------------------- - ------------------------- ------------------------- CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing either 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 two types of Investment 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 B Shares and Class C Shares is based on purchasing arrangements and distribution expenses. Class B Shares have a sales charge included at the time of purchase and are subject to a lower Rule 12b-1 distribution fee. This means that investors can purchase fewer Class B Shares for the same initial investment than Class C Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class C Shares impose a contingent deferred sales charge ("CDSC") on most redemptions made within six years of purchase and have higher distribution costs resulting from greater Rule 12b-1 distribution fees. This means that investors may purchase more Class C Shares than Class B 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 and the CDSC on Class C Shares would be less than the initial sales charge and accumulated Rule 12b-1 fee on Class B Shares purchased at the same time. Investors must also consider how that differential would be offset by the higher yield of Class B 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 B Shares adds an applicable sales charge, and the redemption proceeds of 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 Trust Shares of a Fund may differ slightly from that of Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges 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 B Shares and Class C Shares. It is generally reported using total return, yield and tax equivalent yield (for the High Grade Tax Free 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 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 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 High Grade Tax Free Fund may advertise the tax equivalent yield, which 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 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 B Shares and Class C 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 B Shares, Class C Shares, and Trust Shares of a Fund. Because Class B Shares and Class C Shares are subject to 12b-1 fees, the yield and tax equivalent yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, Class C Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class C 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 B Shares), or (ii) on a contingent deferred basis (in the case of Class C Shares). MINIMUM INVESTMENT You may invest as often as you want in any of 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 B 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 4.00% 4.17% $ 100,000-$ 249,999 3.50% 3.63% $ 250,000-$ 499,999 2.50% 2.56% $ 500,000-$ 749,999 1.50% 1.52% $ 750,000-$ 999,999 1.00% 1.01% $1,000,000-$2,499,999 0.50% 0.50% $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 family, 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 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 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 six 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 4.0% Second 3.0% Third 2.5% Fourth 2.0% Fifth 1.5% Sixth 0.5% Seventh None
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 six 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 C 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 C Shares was accepted. At the end of this seven year period, Class C Shares may automatically convert to Class B Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class C 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 C 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 C Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class B Shares, Class C Shares purchased through the reinvestment of dividends and distributions paid on Class C Shares in a shareholder's Fund acount will be considered to be held in a separate sub- account. Each time any Class C Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class B Shares, an equal pro rata portion of the Class C Shares in the sub-account will also convert to Class B 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 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, State Street Bank and Trust Company of Boston, Massachusetts ("State Street Bank") 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. 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 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their offering price determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 C Shares will not be subject to a CDSC. However, if the shareholder redeems Class C Shares within six 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 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 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 State Street Bank, 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 the 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 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 WITHDRAWAL PLAN If you are a shareholder with an account valued at $10,000 or more, you may have amounts of $100 or more sent from your account to you on a regular monthly or quarterly basis. 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 $70.8 billion in total consolidated assets as of December 31, 1993. Through offices in 36 states and one foreign country, 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 $43.0 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. 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. 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. 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 High Grade Tax Free Fund since its inception in February 1992. 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. Malcolm M. Trevillian is a Vice President of First Union National Bank of North Carolina, N.A., and has been with First Union since 1986. During that time, he has served as a portfolio manager for various pension and profit-sharing accounts maintained with First Union. Mr. Trevillian has managed the Utility Fund since its inception in January 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. 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 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 the average daily net asset value of the Fund 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% for Class B Shares of the Fixed Income Fund, 0.25% for Class B Shares of the Balanced, High Grade Tax Free, U.S. Government, Utility, and Value Funds, and 0.75% for Class C Shares of a 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 its distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of 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 C Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for 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"), 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 serves as custodian and transfer agent, providing 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 Equity and 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 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; 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, 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 4, 1994, First Union National Bank, Charlotte, North Carolina, acting in various capacities for numerous accounts, was the owner of record of 501,994 shares (80.44%) of Utility Fund--Class B Investment Shares; 63,510,816 shares (98.9%) of Balanced Fund--Trust Shares; 35,104,402 shares (95.1%) of Fixed Income Fund--Trust Shares; 25,746,543 shares (96.0%) of Value Fund--Trust Shares; and 1,221,044 shares (81.5%) of U.S. Government Fund--Trust 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. - ------------------------- 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; dividends are declared and paid monthly for the Fixed Income and Utility Funds; and dividends are declared daily and paid monthly for the High Grade Tax Free and U.S. Government 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 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 "High Grade Tax Free 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. HIGH GRADE TAX FREE FUND ADDITIONAL TAX INFORMATION Shareholders of High Grade Tax Free 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. Distributions representing net long-term capital gains realized by the Fund, 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. - ------------------------ OTHER CLASSES ------------------------ - ------------------------ OF SHARES ------------------------ First Union Equity and Income Funds offer three classes of shares: Class B Shares and Class C Shares for individuals and other customers of First Union and Trust Shares for institutional investors. Trust 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. Trust 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 B Shares and Class C Shares will be less than those payable to Trust Shares by the difference between distribution expenses borne by the shares of each respective class. [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] - ------------------------- 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, Transfer Agent, and Dividend Disbursing Agent State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor 331968 3031007 A-R (2/94) FIRST UNION VALUE PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Value Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-07 (9/94) FIRST UNION VALUE PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Value Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 1 Lending of Portfolio Securities 2 Reverse Repurchase Agreements 2 Options Transactions 2 Futures Transactions 3 Portfolio Turnover 4 Investment Limitations 4 TRUST MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 7 BROKERAGE TRANSACTIONS 7 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 8 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 9 DETERMINING NET ASSET VALUE 10 - --------------------------------------------------------------- Determining Market Value of Securities 10 REDEEMING SHARES 10 - --------------------------------------------------------------- Redemption in Kind 10 TAX STATUS 11 - --------------------------------------------------------------- The Fund's Tax Status 11 Shareholders' Tax Status 11 TOTAL RETURN 11 - --------------------------------------------------------------- YIELD 11 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 12 - --------------------------------------------------------------- FINANCIAL STATEMENTS 12 - --------------------------------------------------------------- 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 three classes: Trust 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 Corporation, 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: Federal Farm Credit Banks; Federal Home Loan Banks; Federal National Mortgage Association; Student Loan Marketing Association; and Federal Home Loan Mortgage Corporation. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objectives and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. 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. 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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 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 to attempt to increase its current income. The Fund will maintain its 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 Fund currently does not intend to invest more than 5% of its net assets in options 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"). PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund 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. 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 the 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. 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. 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 PUT OPTIONS ON PORTFOLIO SECURITIES The Fund may purchase put options on portfolio securities to protect against price movements in particular securities in its portfolio. 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. WRITING COVERED CALL OPTIONS The Fund may also write covered call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. The Fund may only sell listed call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any such additional consideration). FUTURES TRANSACTIONS The Fund may enter into currency and other financial futures contracts and write options on such contracts. The Fund intends to enter into such contracts and related options for hedging purposes. The Fund 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 Fund does not make payment or deliver securities upon entering into a futures contract. Instead, it puts 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 Fund may sell or purchase currency and other financial futures contracts. When a futures contract is sold by the 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 Fund sells futures contracts in order to offset a possible decline in the profit on its securities or currencies. If a futures contract is purchased by the 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 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 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 its options positions. The Fund's 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 Fund will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Fund is not able to enter into an offsetting transaction, the Fund 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. 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, 1993 and 1992 were 46% and 56%, 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 CLASS 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 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services. POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice President and Assistant Treasurer Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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, 1993, 1992, and 1991, the Adviser earned advisory fees of $3,016,457, $2,208,618, and $1,374,240, of which $0, $0, and $213,100, was 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., 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, 1993, 1992, and 1991, the Fund paid $894,400, $642,338, and $536,139, 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, 1993, 1992, and 1991, the Fund incurred $526,836, $407,134 and $296,644 in administrative service costs, of which $0, $17,263, and $0, was voluntarily 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 B 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 puchases 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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, 1993, 1992, and 1991, brokers and administrators (financial institutions) received fees in the amount of $694,708, $372,419, and $295,340, 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. 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. Over-the-counter put options will be valued at the mean between the bid and the asked 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' 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 Trust Shares for the one-year period ended December 31, 1993 and for the period from December 31, 1990 (start of performance) to December 31, 1993 were 9.71% and 14.22%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year and five-year periods ended December 31, 1993 and for the period from April 12, 1985 (start of performance) to December 31, 1993 were 4.95%, 11.67%, and 12.27%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from January 25, 1993 (start of performance) to December 31, 1993 was 4.97%. 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. 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, if applicable. The Class C Investment Shares' total return is representative of only eleven months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Trust Shares was 2.97% for the thirty-day period ended December 31, 1993. The Fund's yields for Class B Investment Shares and Class C Investment Shares were 2.60% and 2.22%, respectively, for the thirty-day period ended December 31, 1993. 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Value Portfolio for the fiscal year ended December 31, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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. 3031001B (1/94) FIRST UNION FIXED INCOME PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Fixed Income Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-03 (9/94) FIRST UNION FIXED INCOME PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Fixed Income Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [LOGO] 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 Transactions 2 Futures Transactions 3 Lending of Portfolio Securities 4 Reverse Repurchase Agreements 4 Foreign Currency Transactions 4 Portfolio Turnover 4 Investment Limitations 4 TRUST MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 7 Trustee Liability 8 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 10 DETERMINING NET ASSET VALUE 10 - --------------------------------------------------------------- Determining Market Value of Securities 11 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 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 three classes: Trust 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 objective 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 Corporation); 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: Federal Farm Credit Banks; Federal Home Loan Banks; Federal National Mortgage Association; Student Loan Marketing Association; and Federal Home Loan Mortgage Corporation. 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 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. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. 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. 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 20% of the total value of its assets. OPTIONS 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 to attempt to increase its current income. The Fund will maintain its 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. PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund 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. 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 the 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. 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. 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. WRITING COVERED OPTIONS The Fund may write (i.e., sell) covered call and put options. By writing a call option, the 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, the 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 Fund also may write straddles (combinations of covered puts and calls on the same underlying security). The Fund may only write "covered" options. This means that so long as the Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. The 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 Fund receives a premium from writing a call or put option which it retains whether or not the option is exercised. By writing a call option, the Fund might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Fund might become obligated to purchase the underlying security for more than its current market price upon exercise. 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. 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"). FUTURES TRANSACTIONS The Fund may enter into currency and other financial futures contracts and write options on such contracts. The Fund intends to enter into such contracts and related options for hedging purposes. The Fund 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 Fund does not make payment or deliver securities upon entering into a futures contract. Instead, it puts 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 Fund may sell or purchase currency and other financial futures contracts. When a futures contract is sold by the 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 Fund sells futures contracts in order to offset a possible decline in the profit on its securities or currencies. If a futures contract is purchased by the 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 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 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 its options positions. The Fund's 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 Fund will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Fund is not able to enter into an offsetting transaction, the Fund 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. Although futures and options transactions are intended to enable the Fund to manage market, interest rate or exchange rate risk, unanticipated changes in interest rates, exchange rates or market prices could result in poorer performance than if it had not entered into these transactions. Even if the adviser correctly predicts interest or exchange rate movements, a hedge could be unsuccessful if changes in the value of the Fund's futures position did not correspond to changes in the value of its investments. This lack of correlation between the Fund's futures and securities or currencies positions may be caused by differences between the futures and securities or currencies markets or by differences between the securities or currencies underlying the Fund's futures position and the securities or currencies held by or to be purchased for the Fund. 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. 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, 1993 and 1992 were 73% and 66%, 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. The Fund has no present intention to borrow money in excess of 5% of the value of its net assets during the coming fiscal year. 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. 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services. POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice President and Assistant Treasurer Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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, 1993, 1992, and 1991, the Adviser earned advisory fees of $1,894,693, $1,531,707, and $836,644, of which $0, $0, and $109,677, was 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., 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, 1993, 1992, and 1991, the Fund paid $7,908, $15,573, and $8,504 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, 1993, 1992, and 1991, the Fund incurred $331,342, $282,292, and $174,214 in administrative service costs, of which $0, $0, and $750 was voluntarily 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 B 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 puchases 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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, 1993, 1992, and 1991, brokers and administrators (financial institutions) received fees in the amount of $51,539, $19,643, and $14,456, of which $0, $0, and $3,491 was waived, 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 Fund. 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. Over-the-counter put options will be valued at the mean between the bid and the asked 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' 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 Trust Shares for the one-year period ended December 31, 1993 and for the period from December 31, 1990 (start of performance) to December 31, 1993 were 8.67% and 9.67%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1993 and for the period from January 31, 1989 (start of performance) to December 31, 1993 were 3.99% and 8.62%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from January 25, 1993 (start of performance) to December 31, 1993 was 1.81%. 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. 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, if applicable. The Class C Investment Shares' total return is representative of only eleven months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Trust Shares was 5.07% for the thirty-day period ended December 31, 1993. The Fund's yields for Class B Investment Shares and Class C Investment Shares were 4.98% and 4.31%, respectively, for the thirty-day period ended December 31, 1993. 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 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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Fixed Income Portfolio for the fiscal year ended December 31, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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 CORPORATION CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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 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 CORPORATION 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. 3031005B (2/94) FIRST UNION HIGH GRADE TAX FREE PORTFOLIO (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union High Grade Tax Free Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-02 (9/94) FIRST UNION HIGH GRADE TAX FREE PORTFOLIO (FORMERLY, FIRST UNION INSURED TAX FREE PORTFOLIO) A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union High Grade Tax Free Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 Temporary Investments 1 Lending of Portfolio Securities 2 Portfolio Turnover 2 Municipal Bond Insurance 2 Municipal Bond Insurers 4 Investment Limitations 4 TRUST MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 10 DETERMINING NET ASSET VALUE 10 - --------------------------------------------------------------- Determining Market Value of Securities 10 Valuing Municipal Bonds 11 REDEEMING SHARES 11 - --------------------------------------------------------------- Redemption in Kind 11 TAX STATUS 11 - --------------------------------------------------------------- The Fund's Tax Status 11 TOTAL RETURN 11 - --------------------------------------------------------------- YIELD 12 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 12 - --------------------------------------------------------------- Tax Equivalency Table 13 PERFORMANCE COMPARISONS 13 - --------------------------------------------------------------- FINANCIAL STATEMENTS 14 - --------------------------------------------------------------- APPENDIX 15 - --------------------------------------------------------------- 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: Trust 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 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 municipal bonds that are covered by insurance guaranteeing the timely payment of principal and interest. 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 Corporation ("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 prospectus. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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 year ended December 31, 1993 and the period ended December 31, 1992 were 14% and 7%, 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 fundamental restrictions or policies 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 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. 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". 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice President and Assistant Treasurer Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not being offered. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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, 1993 and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, the Adviser earned advisory fees of $643,946 and $356,258, of which $280,300 and $269,964 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., 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. 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, 1993 and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, the Fund incurred $112,663 and $65,451 in administrative service costs, of which $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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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, 1993, and for the period from February 21, 1992 (commencement of operations) to December 31, 1992, brokers and administrators (financial institutions) received fees in the amount of $456,290 and $178,122, of which $2,256 and $149,539, was waived, 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 Fund. 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 less than 60 days 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' 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 B Investment Shares for the one-year period ended December 31, 1993 and for the period from February 25, 1992 (start of performance) to December 31, 1993 were 8.76% and 9.82%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from January 12, 1993 (start of performance) to December 31, 1993 was 8.20%. Trust Shares were not being offered during the period ended December 31, 1993. 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. 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, if applicable. The Class C Investment Shares' total return is representative of only 11.5 months of investment activity since the commencement of operations. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1993 was 4.23%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1993 was 3.92%. Trust Shares were not being offered during the period ended December 31, 1993. 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 Class B Investment Shares for the thirty-day period ended December 31, 1993 was 5.88%. The Fund's tax equivalent yield for Class C Investment Shares for the thirty-day period ended Decmeber 31, 1993 was 5.44%. Trust Shares were not being offered during the period ended December 31, 1993. 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 1994 FEDERAL INCOME TAX BRACKET: 15.00% 28.00% 31.00% 36.00% 39.60% - ------------------------------------------------------------------------------- JOINT $1- $38,001- $91,851- $140,001- Over RETURN: 38,000 91,850 140,000 250,000 $ 250,000 SINGLE $1- $22,751- $55,101- $115,001- Over RETURN: 22,750 55,100 115,000 250,000 $ 250,000 - ------------------------------------------------------------------------------- TAX-EXEMPT YIELD TAXABLE YIELD EQUIVALENT - ------------------------------------------------------------------------------- 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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union High Grade Tax Free Portfolio for the fiscal year ended December 31, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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 CORPORATION BOND RATING DEFINITIONS AAA--Debt rated "AAA" has the highest rating assigned by Standard & Poor's Corporation. 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. 3031002B (2/94) FIRST UNION BALANCED PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Balanced Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-01 (9/94) FIRST UNION BALANCED PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Balanced Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 Transactions 1 Futures Transactions 3 Lending of Portfolio Securities 4 Reverse Repurchase Agreements 4 Portfolio Turnover 5 Investment Limitations 5 TRUST MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 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 three classes: Trust 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 investment grade bonds (those rated A or higher by Moody's Investors Service, Inc. or Standard & Poor's Corporation) 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 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 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. 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. 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 20% of the total value of its assets. OPTIONS 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 50% of the Fund's net assets. This policy cannot be changed without shareholder approval. The Fund will maintain its 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. PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund 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. 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 the 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 a predetermined 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. The Fund would "go long" to hedge against a decline in market interest rates. 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. WRITING COVERED OPTIONS The Fund may write (i.e., sell) covered call and put options. By writing a call option, the 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, the 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 Fund also may write straddles (combinations of covered puts and calls on the same underlying security). The Fund may only write "covered" options. This means that so long as the Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. The 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 aggregate value of the obligations underlying the puts will not exceed 50% of the Fund's net assets. 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 Fund receives a premium from writing a call or put option which it retains whether or not the option is exercised. By writing a call option, the Fund might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Fund might become obligated to purchase the underlying security for more than its current market price upon exercise. 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. 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"). FUTURES TRANSACTIONS The Fund may enter into currency and other financial futures contracts and write options on such contracts. The Fund intends to enter into such contracts and related options for hedging purposes. The Fund 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 Fund does not make payment or deliver securities upon entering into a futures contract. Instead, it puts 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 Fund may sell or purchase currency and other financial futures contracts. When a futures contract is sold by the 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 Fund sells futures contracts in order to offset a possible decline in the profit on its securities or currencies. If a futures contract is purchased by the 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 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 enter into a 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 its options positions. The Fund's 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 Fund will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Fund is not able to enter into an offsetting transaction, the Fund 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. Although futures and options transactions are intended to enable the Fund to manage market interest rate or exchange rate risk, unanticipated changes in interest rates, exchange rates, or market prices could result in poorer performance than if it had not entered into these transactions. Even if the adviser correctly predicts interest or exchange rate movements, a hedge could be unsuccessful if changes in the value of the Fund's futures position did not correspond to changes in the value of its investments. This lack of correlation between the Fund's futures and securities or currencies positions may be caused by differences between the futures and securities or currencies markets or by differences between the securities or currencies underlying the Fund's futures position and the securities or currencies held by or to be purchased for the Fund. 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. 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, 1993 and 1992 were 19% and 12%, 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. The Fund has no present intention to borrow money in excess of 5% of the value of its net assets during the coming fiscal year. 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. 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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, 1993, 1992, and 1991, the Adviser earned advisory fees of $3,425,786, $2,319,251, and $1,181,762, 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, 1993, 1992, and 1991, the Fund paid $389,044, $152,802, and $150,242, 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, 1993, 1992, and 1991, the Fund incurred $597,752, $427,255, and $243,962, in administrative service costs, 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 B 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 3.50% not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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, 1993, 1992, and 1991, brokers and administrators (financial institutions) received fees in the amount of $295,600, $20,235, and $1,367, respectively, none of which was waived, 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 Fund. 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. Over-the-counter put options will be valued at the mean between the bid and the asked 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' 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 Trust Shares for the one-year period ended December 31, 1993 and for the period from April 1, 1991 (start of performance) to December 31, 1993 were 10.68% and 12.37%, respectively. The Fund's average annual total returns for Class B Investment Shares for the one-year period ended December 31, 1993 and for the period from June 6, 1991 (start of performance) to December 31, 1993 were 5.94% and 10.02%, respectively. The Fund's cumulative total return for Class C Investment Shares for the period from January 25, 1993 (start of performance) to December 31, 1993 was 4.58%. 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. 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, if applicable. The Class C Investment Shares' total return is representative of only 11.5 months of investment activity since the start of performance. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Trust Shares was 3.27% for the thirty-day period ended December 31, 1993. The Fund's yields for Class B Investment Shares and Class C Investment Shares were 2.89% and 2.51%, respectively, for the thirty-day period ended December 31, 1993. 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 Shearson 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Balanced Portfolio for the fiscal year ended December 31, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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 CORPORTION CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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 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. 3031003B (2/94) FIRST UNION U.S. GOVERNMENT PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union U.S. Government Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-05 (9/94) FIRST UNION U.S. GOVERNMENT PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union U.S. Government Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 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 Futures and Options Transactions 2 Lending of Portfolio Securities 5 Restricted Securities 5 Reverse Repurchase Agreements 5 Portfolio Turnover 5 Investment Limitations 5 TRUST MANAGEMENT 7 - --------------------------------------------------------------- Officers and Trustees 7 Fund Ownership 8 Trustee Liability 8 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 9 BROKERAGE TRANSACTIONS 9 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 10 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 10 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 13 - --------------------------------------------------------------- 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 three classes: Trust 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. 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 at the trade date. These securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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 contacts. Additionally, the Fund may buy and sell call and put options on U.S. government securities. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer, who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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. 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 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. 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 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. 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 Rule 144A. The Fund believes that the Staff of the SEC has left the question of determining the liquidity of all restricted securities 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. It is not anticipated that the portfolio trading engaged in by the Fund will result in its annual rate of turnover exceeding 100%. For the period from January 11, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rate for the Fund was 39%. 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 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 has no present intention to borrow money in excess of 5% of the value of its net assets during 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice President and Assistant Treasurer Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Trust Shares of the Fund: First Union National Bank, Trust Accounts, Charlotte, North Carolina, owned 277,887 shares (18.5%). As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: FUBS & Co., Alexandria, Virginia, owned 196,581 shares (5.1%). As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Adviser earned $802,441, of which $465,195 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $139,691 in administrative service costs, of which $30,827 was 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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 11, 1993 (commencement of operations) to December 31, 1993, brokers and administrators (financial institutions) received fees in the amount of $1,068,084, 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 Fund. 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 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 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' 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 cumulative total return for Class B Investment Shares for the period from January 12, 1993 (start of performance) to December 31, 1993 was 3.10%. The Fund's cumulative total return for Class C Investment Shares for the period from January 12, 1993 (start of performance) to December 31, 1993 was 2.68%. The Fund's cumulative total return for Trust Shares for the period from August 25, 1993 (start of performance) to December 31, 1993 was .49%. 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. Class B Shares' total return is representative of only 11.5 months of Fund activity since the commencement of operations. Class C Shares' total return is representative of only 11.5 months of Fund activity since the commencement of operations. Trust Shares' total return is representative of only four months of Fund activity since the commencement of operations. YIELD - -------------------------------------------------------------------------------- The Fund's yield for Class B Investment Shares for the thirty-day period ended December 31, 1993 was 3.93%. The Fund's yield for Class C Investment Shares for the thirty-day period ended December 31, 1993 was 3.60%. The Fund's yield for Trust Shares for the thirty-day period ended December 31, 1993 was 4.35%. 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 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. Advertisements may quote performance information which does not reflect the effect of the sales load. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union U.S. Government Portfolio for the fiscal year ended December 31, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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. 3031008B (2/94) FIRST UNION UTILITY PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Utility Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-06 (9/94) FIRST UNION UTILITY PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Utility Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 Transactions 2 Futures Transactions 3 Portfolio Turnover 4 Investment Limitations 4 TRUST MANAGEMENT 6 - --------------------------------------------------------------- Officers and Trustees 6 Fund Ownership 7 Trustee Liability 7 INVESTMENT ADVISORY SERVICES 8 - --------------------------------------------------------------- Adviser to the Fund 8 Advisory Fees 8 BROKERAGE TRANSACTIONS 8 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 9 - --------------------------------------------------------------- PURCHASING SHARES 9 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 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 11 - --------------------------------------------------------------- YIELD 12 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 12 - --------------------------------------------------------------- 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 three classes: Trust 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: Federal Farm Credit Banks; Federal Home Loan Banks; Federal National Mortgage Association; Student Loan Marketing Association; and Federal Home Loan Mortgage Corporation. 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 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. 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. 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 at the trade date. These securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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 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 to attempt to increase its current income. The Fund will maintain its 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. PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund 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. 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 the 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. 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. 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. WRITING COVERED OPTIONS The Fund may write (i.e., sell) covered call and put options. By writing a call option, the 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, the 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 Fund also may write straddles (combinations of covered puts and calls on the same underlying security). The Fund may only write "covered" options. This means that so long as the Fund is obligated as the writer of a call option, it will own the underlying securities subject to the option or, in the case of call options on U.S. Treasury bills, the Fund might own substantially similar U.S. Treasury bills. The 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 Fund receives a premium from writing a call or put option which it retains whether or not the option is exercised. By writing a call option, the Fund might lose the potential for gain on the underlying security while the option is open, and by writing a put option, the Fund might become obligated to purchase the underlying security for more than its current market price upon exercise. 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 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"). FUTURES TRANSACTIONS The Fund may enter into currency and other financial futures contracts and write options on such contracts. The Fund intends to enter into such contracts and related options for hedging purposes. The Fund 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 Fund does not make payment or deliver securities upon entering into a futures contract. Instead, it puts 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 Fund may sell or purchase currency and other financial futures contracts. When a futures contract is sold by the 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 Fund sells futures contracts in order to offset a possible decline in the profit on its securities or currencies. If a futures contract is purchased by the 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 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 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 its options positions. The Fund's 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 Fund will be able to enter into an offsetting transaction with respect to a particular contract at a particular time. If the Fund is not able to enter into an offsetting transaction, the Fund 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. 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%. 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 has no present intention to borrow money in excess of 5% of the value of its net assets during 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not effective. As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. 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. 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. 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. 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. 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. 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 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 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. YIELD - -------------------------------------------------------------------------------- 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. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S CORPORATION CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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 CORPORATION 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. 3092403B (2/93) FIRST UNION MANAGED BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST SHARES STATEMENT OF ADDITIONAL INFORMATION This Statement of Additional Information should be read with the prospectus of Trust Shares for First Union Managed Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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, 1994 [LOGO] 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 Transactions 2 Lending of Portfolio Securities 3 Reverse Repurchase Agreements 3 Portfolio Turnover 3 Investment Limitations 3 TRUST MANAGEMENT 5 - --------------------------------------------------------------- Officers and Trustees 5 Fund Ownership 6 Trustee Liability 6 INVESTMENT ADVISORY SERVICES 7 - --------------------------------------------------------------- Adviser to the Fund 7 Advisory Fees 7 BROKERAGE TRANSACTIONS 7 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 8 - --------------------------------------------------------------- PURCHASING SHARES 8 - --------------------------------------------------------------- Distribution Plan (Investment Shares) 9 DETERMINING NET ASSET VALUE 9 - --------------------------------------------------------------- Determining Market Value of Securities 9 REDEEMING SHARES 10 - --------------------------------------------------------------- Redemption in Kind 10 TAX STATUS 10 - --------------------------------------------------------------- The Fund's Tax Status 10 Shareholders' Tax Status 10 TOTAL RETURN 10 - --------------------------------------------------------------- YIELD 11 - --------------------------------------------------------------- PERFORMANCE COMPARISONS 11 - --------------------------------------------------------------- FINANCIAL STATEMENTS 12 - --------------------------------------------------------------- APPENDIX 13 - --------------------------------------------------------------- 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 three classes of shares: Trust Shares ("Shares"), Class B Investment Shares (not currently offered) and Class C Investment Shares (not currently offered). This Statement of Additional Information relates to the Trust 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 investment grade bonds which include domestic issues of corporate debt obligations rated A or better by Moody's Investors Service, Inc. or Standard & Poor's Corporation; 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: Federal Farm Credit Banks; Federal Home Loan Banks; Federal National Mortgage Association; Student Loan Marketing Association; and Federal Home Loan Mortgage Corporation. 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 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. WHEN-ISSUED AND DELAYED DELIVERY TRANSACTIONS The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Fund. 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. 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 20% of the total value of its assets. OPTIONS 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 50% of the Fund's net assets. This policy cannot be changed without shareholder approval. The Fund will maintain its 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. PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund 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. 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 the 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 a predetermined 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. The Fund would "go long" to hedge against a decline in market interest rates. 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. PURCHASING 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 in its portfolio. 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 securities from the seller. WRITING COVERED PUT AND CALL OPTIONS The Fund may also write covered put and call options to generate income. As the writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As the writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any such additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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, 1993 and 1992 were 53% and 56%, 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. 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". TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services. POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice Treasurer President and Assistant Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Class B and Class C Investment Shares of the Fund were not being offered. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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, 1993, 1992, and 1991, the Adviser earned advisory fees of $576,619, $591,232 and $351,933, 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, 1993, 1992, and 1991, the Fund paid $1,662, $16,922, and $3,375 in commissions on brokerage transactions, respectively. 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, 1993, 1992, and 1991, the Fund incurred $101,082, $109,032, and $72,661, in administrative service costs, of which $36,701, $52,759, and $0 was voluntarily 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 prospectus under "How to Buy Shares." REDUCING THE SALES CHARGE The sales charge can be reduced on the purchase of 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 First Union Funds 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 a 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 3.50%, not 4.00%. 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 any First Union Funds 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 4.0% 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 purchases 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 First Union Funds with a sales charge, and $70,000 in Shares of another Fund with a sales charge, 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 PLAN (INVESTMENT SHARES) With respect to the 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 Investment Shares. The Plan is designed to (i) stimulate brokers to provide distribution and administrative support services to the Fund and its holders of Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and its holders of 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 Investment Shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Fund reasonably requests for its 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. 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 financial institutions may be required to register as dealers pursuant to state law. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. 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. Over-the-counter put options will be valued at the mean between the bid and the asked prices. 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' 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 Trust Shares for the one year period ended December 31, 1993 and for the period from April 1, 1991 (start of performance) to December 31, 1993 were 10.59% and 10.15%, respectively. Investment Shares were not being offered during the period ended December 31, 1993. The average annual total return for Trust 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 Trust Shares for the thirty-day period ended December 31, 1993 was 5.26%. Investment Shares were not being offered during the period ended December 31, 1993. The yield for Trust 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 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, 1993 are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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 CORPORATION CORPORATE BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's. 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 CORPORATION 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. 2120212B (2/94) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS (Portfolios of First Union Funds) Trust Shares - -------------------------------------------------------------------------------- Supplement to Prospectus dated February 28, 1994 Effective September 1, 1994, First Union Single State Municipal Bond Funds (the "Funds") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. A. Please delete the "Summary of Fund Expenses" table on pages 4 and 5 and replace it with the following: - ------------------------- SUMMARY OF ------------------------- - ------------------------- FUND EXPENSES ------------------------- First Union Single State Municipal Bond Funds Trust Shares
North South Florida Georgia Carolina Carolina Virginia Municipal Municipal Municipal Municipal Municipal Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund --------- --------- --------- --------- --------- Trust Shares-- Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)... None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................... 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 Redemption Fee (as a percentage of amount redeemed, if applicable)....... None None None None None Exchange Fee........................... None None None None None Annual Trust Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (1)...... 0.00% 0.00% 0.16% 0.00% 0.00% 12b-1 Fees............................. None None None None None Total Other Expenses (after waiver and reimbursement) (2).................... 0.37% 0.37% 0.38% 0.00% 0.37% Total Trust Shares Operating Expenses (3)..................... 0.37% 0.37% 0.54% 0.00% 0.37%
(1) The estimated management fees 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 fee for each Fund is 0.50%. - ------------------------- SUMMARY OF ------------------------- - ------------------------- FUND EXPENSES ------------------------- (Continued) First Union Single State Municipal Bond Funds Trust Shares (2) Total Other Expenses for Florida, Georgia, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.73%, 2.17%, 2.71%, and 2.41%, respectively, absent the anticipated voluntary waivers by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (3) Total Trust Shares Operating Expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 1.23%, 2.67%, 0.88%, 3.21%, and 2.91%, respectively, absent the anticipated 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, 1994. 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, assuming (1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Trust Shares. Florida Municipal Bond Fund.................................. $4 $12 Georgia Municipal Bond Fund.................................. $4 $12 North Carolina Municipal Bond Fund........................... $6 $17 South Carolina Municipal Bond Fund........................... $0 $ 0 Virginia Municipal Bond Fund................................. $4 $12
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 is based on estimated data for the fiscal year ending December 31, 1994. The information set forth in the foregoing table and example relates only to Trust Shares of the Funds. The Funds also offer three additional classes of shares called Class B Shares, Class C Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Class B Shares, Class C Shares and Class D Shares are subject to certain of the same expenses as Trust Shares. However, Class B Shares are subject to a 12b-1 fee of 0.25 of 1%, Class C Shares and Class D 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 B Shares bear a maximum front-end sales charge of 4.75%, Class C Shares bear a maximum contingent deferred sales charge of 5.00% and Class D Shares bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares". September 1, 1994 FEDERATED SECURITIES CORP. - -------------------------------------------------------------------------------- Distributor G00389-15-A (9/94) FIRST UNION SINGLE STATE - ------------------------ MUNICIPAL BOND ------------------------ - ------------------------ ------------------------ FUNDS Portfolios of First Union Funds TRUST SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1994 First Union Funds (the "Trust") is a mutual fund with 15 portfolios, offering a variety of investment opportunities. The Trust currently includes five non- diversified Single State Municipal Bond Funds, seven diversified Equity and Income Funds and three diversified Money Market Funds. They are: Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. Equity and Income Funds .First Union Balanced Portfolio; .First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio (Investment Shares not currently offered); . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and .First Union Value 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 Trust Shares of First Union Single State Municipal Bond Funds. It concisely describes the information which you should know before investing in Trust Shares of any of the First Union Single State Municipal Bond Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Single State Municipal Bond Fund in its Statement of Additional Information dated February 28, 1994, 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 REDEEM SHARES 15 - ------------------------------------- ------------------------------------- SUMMARY OF FUND EXPENSES 4 MANAGEMENT OF FIRST UNION FUNDS 15 - ------------------------------------- ------------------------------------- FEES AND EXPENSES 16 FINANCIAL HIGHLIGHTS 5 - ------------------------------------- ------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 9 - ------------------------------------- SHAREHOLDER RIGHTS AND PRIVILEGES 17 ------------------------------------- OTHER INVESTMENT POLICIES 11 - ------------------------------------- DISTRIBUTIONS AND TAXES 18 ------------------------------------- SHAREHOLDER GUIDE 12 - ------------------------------------- TAX INFORMATION 19 ------------------------------------- HOW TO BUY SHARES 13 - ------------------------------------- OTHER CLASSES OF SHARES 21 ------------------------------------- HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER ADDRESSES Inside Back Cover FIRST UNION FUND 14 ------------------------------------- - ------------------------------------- - ------------------------ 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 15 portfolios, each representing a different First Union Fund. Each Single State Municipal Bond Fund currently offers three classes of shares: Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares"), and Trust Shares. Class B Shares and Class C Shares are sold to individuals and other customers of First Union (the "Adviser"). Trust Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). This prospectus relates only to Trust Shares ("Shares") of the First Union Single State Municipal Bond Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following five Single State Municipal Bond 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; and . 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. 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 Trust Shares of any of the Single State Municipal Bond 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 SINGLE STATE MUNICIPAL BOND FUNDS TRUST SHARES
North South Florida Georgia Carolina Carolina Virginia Municipal Municipal Municipal Municipal Municipal Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund --------- --------- --------- --------- --------- TRUST SHARES-- SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offering price)... None None None None None Maximum Sales Load Imposed on Rein- vested Dividends (as a percentage of offering price)................................ None None None None None Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable).............. None None None None None Redemption Fee (as a percentage of amount redeemed, if applicable)........................ None None None None None Exchange Fee........................... None None None None None ANNUAL TRUST SHARES OPERATING EXPENSES* (As a percentage of projected average net assets) Management Fee (after waiver) (1)...... 0.00% 0.00% 0.16% 0.00% 0.00% 12b-1 Fees............................. None None None None None Total Other Expenses (after waiver and reimbursement) (2).................... 0.37% 0.37% 0.38% 0.00% 0.37% Total Trust Shares Operating Ex- penses (3)............................ 0.37% 0.37% 0.54% 0.00% 0.37%
(1) The estimated management fees 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 fee for each Fund is 0.50%. (2) Total Other Expenses for Florida, Georgia, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.73%, 2.17%, 2.71%, and 2.41%, respectively, absent the anticipated voluntary waivers by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (3) Total Trust Shares operating expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 1.23%, 2.67%, 0.88%, 3.21%, and 2.91%, respectively, absent the anticipated 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, 1994. 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, assuming (1) a 5% annual return and (2) redemption at the end of each time period. The Funds charge no redemption fees for Trust Shares. Florida Municipal Bond Fund.................................. $4 $12 Georgia Municipal Bond Fund.................................. $4 $12 North Carolina Municipal Bond Fund........................... $6 $17 South Carolina Municipal Bond Fund........................... $0 $ 0 Virginia Municipal Bond Fund................................. $4 $12
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 IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. The information set forth in the foregoing table and example relates only to Trust Shares of the Funds. The Funds also offer two additional classes of shares called Class B Shares and Class C Shares. Class B Shares and Class C Shares are subject to certain of the same expenses as Trust Shares. However, Class B Shares are subject to a 12b-1 fee of .25 of 1%, and Class C Shares are subject to a 12b-1 fee of .75 of 1%. In addition, Class B Shares bear a maximum front-end sales load of 4.00%, while Class C Shares bear a maximum contingent deferred sales load of 4.00%. See "Other Classes of Shares." - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION FLORIDA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES (A) SHARES (A) ------------------ ------------------- PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993** - --------------------------------------- ------------------ ------------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - --------------------------------------- INCOME FROM INVESTMENT OPERATIONS - --------------------------------------- Net investment income 0.22 0.20 - --------------------------------------- Net realized and unrealized gain 0.34 0.34 (loss) on investments ------ ------ - --------------------------------------- Total from investment operations 0.56 0.54 - --------------------------------------- LESS DISTRIBUTIONS - --------------------------------------- Dividends to shareholders from net in- (0.22) (0.20) vestment income ------ ------ - --------------------------------------- NET ASSET VALUE, END OF PERIOD $10.34 $10.34 - --------------------------------------- ------ ------ TOTAL RETURN*** 5.63% 5.40% - --------------------------------------- RATIOS TO AVERAGE NET ASSETS - --------------------------------------- Expenses 0.25%(c) 0.75%(c) - --------------------------------------- Net investment income 4.92%(c) 4.46%(c) - --------------------------------------- Expense waiver/reimbursement (b) 1.58%(c) 1.58%(c) - --------------------------------------- SUPPLEMENTAL DATA - --------------------------------------- Net assets, end of period (000 omit- ted) $8,110 $18,383 - --------------------------------------- Portfolio turnover rate 3% 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. *** Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION GEORGIA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES (A) SHARES (A) ------------------ ------------------ PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993* - ---------------------------------------- ------------------ ------------------ NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ---------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------------------------- Net investment income 0.201 0.179 - ---------------------------------------- Net realized and unrealized gain (loss) 0.193 0.193 on investments ------- ------- - ---------------------------------------- Total from investment operations 0.394 0.372 - ---------------------------------------- LESS DISTRIBUTIONS - ---------------------------------------- Dividends to shareholders from net in- vestment income (0.201) (0.179) - ---------------------------------------- Distributions to shareholders from net realized gain on investment transac- (0.003) (0.003) tions ------- ------- - ---------------------------------------- TOTAL DISTRIBUTIONS (0.204) (0.182) - ---------------------------------------- ------- ------- NET ASSET VALUE, END OF PERIOD $10.19 $10.19 - ---------------------------------------- ------ ------ TOTAL RETURN** 3.96% 3.74% - ---------------------------------------- RATIOS TO AVERAGE NET ASSETS - ---------------------------------------- Expenses 0.25%(c) 0.75%(c) - ---------------------------------------- Net investment income 4.71%(c) 4.15%(c) - ---------------------------------------- Expense waiver/reimbursement (b) 6.57%(c) 6.57%(c) - ---------------------------------------- SUPPLEMENTAL DATA - ---------------------------------------- Net assets, end of period (000 omitted) $817 $3,692 - ---------------------------------------- Portfolio turnover rate 15% 15% - ----------------------------------------
* 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) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES (B) SHARES (B) ------------------- ------------------- PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993** DECEMBER 31, 1993** - ------------------------------------- ------------------- ------------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ------------------------------------- Net investment income 0.46 0.42 - ------------------------------------- Net realized and unrealized gain (loss) on 0.64 0.64 investments ------ ------ - ------------------------------------- Total from investment operations 1.10 1.06 - ------------------------------------- LESS DISTRIBUTIONS - ------------------------------------- Dividends to shareholders from net investment income (0.46) (0.42) - ------------------------------------- Distributions to shareholders from net realized gains on investment (0.03) (0.03) transactions ------ ------ - ------------------------------------- Total distributions (0.49) (0.45) - ------------------------------------- ------ ------ NET ASSET VALUE, END OF PERIOD $10.61 $10.61 - ------------------------------------- ------ ------ TOTAL RETURN* 11.28% 10.80% - ------------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------------- Expenses 0.32%(a) 0.79%(a) - ------------------------------------- Net investment income 4.91%(a) 4.47%(a) - ------------------------------------- Expense waiver/reimbursement(c) 0.93%(a) 0.95%(a) - ------------------------------------- SUPPLEMENTAL DATA - ------------------------------------- Net assets, end of period (000 omit- ted) $12,739 $45,168 - ------------------------------------- Portfolio turnover rate 57% 57% - -------------------------------------
* Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. ** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. (a) Computed on an annualized basis. (b) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (c) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION VIRGINIA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES (A) SHARES (A) ------------------ ------------------ PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993* - ---------------------------------------- ------------------ ------------------ NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ---------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------------------------- Net investment income 0.20 0.17 - ---------------------------------------- Net realized and unrealized gain (loss) 0.19 0.19 on investments ------ ------ - ---------------------------------------- Total from investment operations 0.39 0.36 - ---------------------------------------- LESS DISTRIBUTIONS - ---------------------------------------- Dividends to shareholders from net in- (0.20) (0.17) vestment income ------ ------ - ---------------------------------------- NET ASSET VALUE, END OF PERIOD $10.19 $10.19 - ---------------------------------------- ------ ------ TOTAL RETURN** 3.89% 3.66% - ---------------------------------------- RATIOS TO AVERAGE NET ASSETS - ---------------------------------------- Expenses 0.25%(b) 0.75%(b) - ---------------------------------------- Net investment income 4.64%(b) 4.25%(b) - ---------------------------------------- Expense waiver/reimbursement (c) 7.50%(b) 7.50%(b) - ---------------------------------------- SUPPLEMENTAL DATA - ---------------------------------------- Net assets, end of period (000 omitted) $1,306 $2,235 - ---------------------------------------- Portfolio turnover rate 0% 0% - ----------------------------------------
* 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) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) Computed on an annualized basis. (c) The voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, 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. 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 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. 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 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 interest retains its tax-free status when distributed to the Fund's shareholders. In addition, at least 65% of the value of each Fund's total assets will be invested in municipal bonds of the particular state after which the Fund is named. 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 Fund seeks to achieve its investment objective by investing principally in municipal obligations, including industrial development bonds, of its designated state. 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 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 Funds will invest are subject to one or more of the following quality standards: rated Baa or better by Moody's Investors Service, Inc. ("Moody's") or BBB or better by Standard & Poor's Corporation ("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. 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. However, certain temporary investments will generate income which is subject to state taxes. 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. 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. - ------------------------ 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 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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 of the value of their total assets. 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 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. The Funds do not use these transactions for speculation or leverage. Options and futures may be volatile investments and involve certain risks which might result in lowering the Funds' returns. The three principal areas of risk include: (1) lack of a liquid secondary market for a futures or option contract when the Fund wants to close out its position; (2) imperfect correlation of changes in the prices of futures or options contracts with the prices of the securities in the Fund's portfolio; and (3) incorrect forecasts by the Adviser of interest rates, market values or other economic factors. In these events, the Funds may lose money on the futures contract or option. RESTRICTED AND ILLIQUID SECURITIES The Funds may not invest more than 15% of their total 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 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 its net assets. 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 a Fund may borrow up to one-third of the value of its total assets and pledge assets to secure such borrowings. NON-DIVERSIFICATION Each Fund 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 Fund 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. NEW ISSUERS The 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. - ------------------------ SHAREHOLDER GUIDE ------------------------ - ------------------------ ------------------------ SHARE PRICE CALCULATION In the case of no-load Funds, the net asset value (NAV), 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 Trust Shares may differ slightly from that of Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges 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 Trust 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 Trust 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 Trust 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 Trust Shares, Class B Shares, and Class C Shares of a Fund. Because Class B Shares and Class C Shares are subject to 12b-1 fees, the yield and tax equivalent yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, 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 C 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 any of the Funds. There are no sales charges imposed on Trust 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 Trust 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, State Street Bank and Trust Company of Boston, Massachusetts ("State Street Bank") 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 Trust Shares of one First Union Fund for Trust 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their net asset value determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 $70.8 billion in total consolidated assets as of December 31, 1993. Through offices in 36 states and one foreign country, 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 $43.0 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. 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. 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. From time to time, to the extent consistent with the objectives, policies, and restrictions of the Funds, the Funds may invest in securities of issuers with which the Adviser has a lending relationship. FUND ADMINISTRATION Federated Securities Corp., 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"), 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 serves as custodian and 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 Single State Municipal Bond 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 TRUST 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 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; 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, 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 4, 1994, First Union Brokerage Services & Co., for the exclusive benefit of Robert Allen Jones and Larry Allen Jones of Florence, South Carolina, and for the exclusive benefit of Doris G. Foster and John H. Foster of Greenville, South Carolina, and acting in various capacities for numerous accounts, was the owner of record of 2,402 Shares (60.49%) and 1,493 Shares (37.59%), respectively, of the South Carolina Municipal Bond Fund--Class B Investment Shares, and therefore, may, for certain purposes, be deemed to control the South Carolina Municipal Bond 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. - ------------------------ 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 Funds 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 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 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 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 dividends to the extent that such dividends 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. To the extent that distributions from the Fund are attributable to capital gains or other sources, such distributions will not be exempt from South Carolina income taxation. 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 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 Single State Municipal Bond Funds offer three classes of shares: Trust Shares for institutional investors and Class B Shares and Class C Shares for individuals and other customers of First Union. Class B Shares and Class C Shares of First Union Single State Municipal Bond 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 B Shares), or (ii) on a contingent deferred basis (the Class C Shares). Shareholders of record in any First Union Fund at October 12, 1990, and the members of their immediate family, 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. Class B and Class C Investment Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of .25 of 1% for Class B Shares and .75 of 1% for Class C Shares of each Fund's average daily net asset value. 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 B Shares and Class C Shares will be less than those payable to Trust Shares by the difference between distribution expenses borne by the shares of each respective class. [This Page Intentionally Left Blank] [This Page Intentionally Left Blank] - ------------------------ 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, Transfer Agent, and Dividend Disbursing Agent State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp. Distributor 3052402A-1 (2/94) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS (Portfolios of First Union Funds) Class B Investment Shares Class C Investment Shares - -------------------------------------------------------------------------------- Supplement to Prospectus dated February 28, 1994 Effective September 1, 1994, First Union Single State Municipal Bond Funds (the "Funds") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. A. Please delete the "Summary of Fund Expenses" table on pages 4 and 5 and replace it with the following: - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS B SHARES
North South Florida Georgia Carolina Carolina Virginia Municipal Municipal Municipal Municipal Municipal Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund Class B 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% Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................................. 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 Redemption Fee (as a percentage of amount redeemed, if applicable)........ None None None None None Exchange Fee............................ None None None None None Annual Class B Shares Operating Expenses (As a percentage of projected average net assets) Management Fee (after waiver) (1)....... 0.00% 0.00% 0.16% 0.00% 0.00% 12b-1 Fees (2).......................... 0.25% 0.25% 0.25% 0.25% 0.25% Total Other Expenses (after waiver and reimbursement) (3)................. 0.37% 0.37% 0.38% 0.00% 0.37% Total Class B Shares Operating Expenses (4)...................... 0.62% 0.62% 0.79% 0.25% 0.62%
(1) The estimated management fees have been reduced to reflect the anticipated voluntary waivers by the Adviser. However, the North Carolina Municipal Bond Fund's management fee has been reduced to reflect the expected voluntary waiver 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 B Shares can pay up to 0.75% of Class B Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit the Class B Shares' 12b-1 payments to 0.25% of Class B Shares' average daily net assets. (3) Total Other Expenses for Florida, Georgia, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.73%, 2.17%, 2.71%, and 2.41%, respectively, absent the anticipated voluntary waiver by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The annual Class B Shares Operating Expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bonds Funds were 0.25%, 0.25%, 0.32%, and 0.25%, respectively, for the period ended December 31, 1993. Total Class B Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds, absent the voluntary waivers and reimbursements of other operating expenses, were 1.83%, 6.82%, 1.25%, and 7.75%, respectively, for the period ended December 31, 1993. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS B SHARES The annual Class B Shares operating expenses in the table above are based on estimated expenses expected during the fiscal year ending December 31, 1994. Total Class B Shares operating expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 1.48%, 2.92%, 1.13%, 3.46%, and 3.16%, respectively, absent the anticipated voluntary waivers and reimbursements described above in notes 1 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. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charges 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. The Funds charge no redemption fees for Class B Shares. Florida Municipal Bond Fund................. $54 $66 $80 $121 Georgia Municipal Bond Fund................. $54 $66 $80 $121 North Carolina Municipal Bond Fund.......... $55 $72 $89 $141 South Carolina Municipal Bond Fund.......... $50 $55 N/A N/A Virginia Municipal Bond Fund................ $54 $66 $80 $121
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 is based on estimated data for the fiscal year ending December 31, 1994. 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 Trust Shares, Class C Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares, Class C Shares and Class D Shares are subject to certain of the same expenses as Class B Shares. However, Trust Shares bear no sales load or 12b-1 fee. Class C 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 charge. Class D 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 1.00% and bear no front-end sales charge. See "Other Classes of Shares." B. Please delete the "Summary of Fund Expenses" table on pages 6 and 7 and replace it with the following: FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS C SHARES
Florida Georgia Municipal Municipal North Carolina Bond Fund Bond Fund Municipal Bond Fund ----------------------------- --------------------------- --------------------------- Class C 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 5% during the first year, 5% during the first year, 5% during the first year, percentage of original purchase price or 4% during the second year, 4% during the second year, 4% during the second year, redemption proceeds, as applicable) (1).. 3% during the third year, 3% during the third year, 3% during the third year, 3% during the fourth year, 3% during the fourth year, 3% during the fourth year, 2% during the fifth year, 2% during the fifth year, 2% during the fifth year, 1% during the sixth year, 1% during the sixth year, 1% during the sixth year, and 0% after the sixth year and 0% after the sixth year and 0% after the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable)................. None None None Exchange Fee.............................. None None None Annual Class C Shares (As a percentage of projected average net assets) Management Fee (after waiver) (2)......... 0.00% 0.00% 0.16% 12b-1 Fees................................ 0.75% 0.75% 0.75% Total Other Expenses (after waiver and reimbursement) (3)...................... 0.62% 0.62% 0.63% Shareholder Service Fee............... 0.25% Total Class C Shares Operating Expenses (4)....................... 1.37% 1.37% 1.54%
- -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS C SHARES
South Carolina Virginia Municipal Municipal Bond Fund Bond Fund --------------------------- --------------------------- Class C Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)........................................... None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)............................. None None Contingent Deferred Sales Charge (as a percentage of 5% during the first year, 5% during the first year, original purchase price or redemption proceeds, as 4% during the second year, 4% during the second year, applicable) (1)........................................... 3% during the third year, 3% during the third year, 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, and 0% after the sixth year and 0% after the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable)............................................... 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% 0.00% 12b-1 Fees................................................. 0.75% 0.75% Total Other Expenses (after waiver and reimbursement) (3).. 0.25% 0.62% Shareholder Service Fee................................. 0.25% Total Class C Shares Operating Expenses (4)........... 1.00% 1.37%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than six 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 estimated management fees have been reduced to reflect the anticipated voluntary waivers by the Adviser. However, the North Carolina Municipal Bond Fund's management fee has been reduced to reflect the expected voluntary waiver 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, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.98%, 2.42%, 2.96% and 2.66%, respectively, absent the anticipated voluntary waiver by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The annual Class C Shares Operating Expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds were 0.75%, 0.75%, 0.79%, and 0.75%, respectively, for the period ended December 31, 1993. Total Class C Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds, absent the voluntary waivers and reimbursements of other operating expenses, were 2.33%, 7.32%, 1.74%, and 8.25%, respectively, for the period ended December 31, 1993. The annual Class C Shares Operating Expenses in the table above are based on estimated expenses expected during the fiscal year ending December 31, 1994. Total Class C Shares operating expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 2.23%, 3.67%, 1.88%, 4.21%, and 3.91%, respectively, absent the anticipated 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. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charges permitted under the rules of the National Association of Securities Dealers, Inc. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS C 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. Florida Municipal Bond Fund................. $66 $77 $99 $165 Georgia Municipal Bond Fund................. $66 $77 $99 $165 North Carolina Municipal Bond Fund.......... $67 $82 $108 $183 South Carolina Municipal Bond Fund.......... $62 $66 N/A N/A Virginia Municipal Bond Fund................ $66 $77 $99 $165 You would pay the following expenses on the same investment, assuming no redemptions: Florida Municipal Bond Fund................. $14 $43 $75 $165 Georgia Municipal Bond Fund................. $14 $43 $75 $165 North Carolina Municipal Bond Fund.......... $16 $49 $84 $183 South Carolina Municipal Bond Fund.......... $10 $32 N/A N/A Virginia Municipal Bond Fund................ $14 $43 $75 $165
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 is based on estimated data for the fiscal year ending December 31, 1994. 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 Trust Shares, Class B Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares, Class B Shares and Class D Shares are subject to certain of the same expenses as Class C Shares. However, Trust Shares bear no sales charge or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1%, bear a maximum front-end sales charge of 4.75%, and bear no contingent deferred sales charge. Class D 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 1.00% and bear no front-end sales charge. See "Other Classes of Shares." C. Please insert the following "Summary of Fund Expenses" table on pages 8 and 9 for Class D Shares: FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS D SHARES
North South Florida Georgia Carolina Carolina Virginia Municipal Municipal Municipal Municipal Municipal Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund Class D Shares-- --------------- --------------- --------------- --------------- --------------- Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)..... None None None None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).................................. None None None None None Contingent Deferred Sales Charge (as a 1% during first 1% during first 1% during first 1% during first 1% during first percentage of original purchase price or year, and 0% year, and 0% year, and 0% year, and 0% year, and 0% redemption proceeds, as applicable) (1). after the after the after the after the after the first year first year first year first year first year Redemption Fees (as a percentage of amount redeemed, if applicable) None None None None None Exchange Fee............................. None None None None None Annual Class D Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (2)........ 0.00% 0.00% 0.16% 0.00% 0.00% 12b-1 Fees............................... 0.75% 0.75% 0.75% 0.75% 0.75% Total Other Expenses (after waiver ) (3). 0.62% 0.62% 0.63% 0.25% 0.62% Shareholder Service Fee................ 0.25% Total Class D Shares Operating Expenses (4)........................ 1.37% 1.37% 1.54% 1.00% 1.37%
(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. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (Continued) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS D SHARES (2) The estimated management fees have been reduced to reflect the anticipated voluntary waiver 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, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.98%, 2.42%, 2.96% and 2.66%, respectively, absent the anticipated voluntary waiver by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) Total Class D Shares operating expenses for Florida, Georgia, North Carolina, South Carolina and Virginia Municipal Bond Funds are estimated to be 2.23%, 3.67%, 1.88%, 4.21% and 3.91%, respectively, absent the anticipated 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, 1994. 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 charge 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: Florida Municipal Bond Fund.................................. $24 $43 Georgia Municipal Bond Fund.................................. $24 $43 North Carolina Municipal Bond Fund........................... $26 $49 South Carolina Municipal Bond Fund........................... $21 $32 Virginia Municipal Bond Fund................................. $24 $43 You would pay the following expenses on the same investment, assuming no redemptions: Florida Municipal Bond Fund.................................. $14 $43 Georgia Municipal Bond Fund.................................. $14 $43 North Carolina Municipal Bond Fund........................... $16 $49 South Carolina Municipal Bond Fund........................... $10 $32 Virginia Municipal Bond Fund................................. $14 $43
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, 1994. The information set forth in the foregoing table and example relates only to Class D Shares of the Funds. The Funds also offer three additional classes of shares called Trust Shares, Class B Shares and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales load or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales charge 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%, bear a maximum contingent deferred sales charge of 5.00% and bear no front-end sales charge. See "Other Classes of Shares." D. Please delete the table (for Class B Investment Shares) under the section entitled "What Shares Cost" on page 17 and replace it with the following:
Sales Charge as a Percentage of Sales Charge as a Amount of Public Offering Percentage of Net Transaction Price Amount Invested ----------- --------------- ----------------- $0-99,999 4.75% 4.25% $100,000-249,999 3.75% 3.25% $250,000-499,999 3.00% 2.50% $500,000-1,000,000 2.00% 1.75% $1,000,000-2,500,000 1.00% 1.00% $2,500,000 and above 0.25% 0.25%
E. Please delete the table (for Class C Investment Shares) under the section entitled "What Shares Cost" on page 18 and replace it with the following:
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%
September 1, 1994 FEDERATED SECURITIES CORP. - -------------------------------------------------------------------------------- Distributor G00389-16-B (9/94) P R O S P E C T U S FIRST UNION SINGLE STATE MUNICIPAL BOND PORTFOLIOS CLASS B AND C INVESTMENT SHARES FEBRUARY 28, 1994 LOGO OF FIRST UNION FUNDS FORMERLY THE SALEM FUNDS FIRST UNION SINGLE STATED - ------------------------ MUNICIPAL BOND ------------------------ - ------------------------ ------------------------ FUNDS Portfolios of First Union Funds CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S February 28, 1994 First Union Funds (the "Trust") is a mutual fund with 15 portfolios, offering a variety of investment opportunities. The Trust currently includes five non- diversified Single State Municipal Bond Funds, seven diversified Equity and Income Funds and three diversified Money Market Funds. They are: Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. Equity and Income Funds .First Union Balanced Portfolio; .First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio (Investment Shares not currently offered); . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and .First Union Value 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 B Investment Shares ("Class B Shares") and Class C Investment Shares ("Class C Shares") of First Union Single State Municipal Bond Funds. It concisely describes the information which you should know before investing in Class B Shares or Class C Shares of any of the First Union Single State Municipal Bond Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union Single State Municipal Bond Fund in its Statement of Additional Information dated February 28, 1994, 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 - ------------------------------------- SUMMARY OF FUND EXPENSES 4 - ------------------------------------- FINANCIAL HIGHLIGHTS 7 - ------------------------------------- INVESTMENT OBJECTIVES AND POLICIES 12 - ------------------------------------- OTHER INVESTMENT POLICIES 14 - ------------------------------------- SHAREHOLDER GUIDE 15 - ------------------------------------- HOW TO BUY SHARES 17 - ------------------------------------- HOW TO REDEEM SHARES 20 - ------------------------------------- ADDITIONAL SHAREHOLDER SERVICES 20 - ------------------------------------- MANAGEMENT OF FIRST UNION FUNDS 21 - ------------------------------------- FEES AND EXPENSES 23 - ------------------------------------- SHAREHOLDER RIGHTS AND PRIVILEGES 23 - ------------------------------------- DISTRIBUTIONS AND TAXES 24 - ------------------------------------- TAX INFORMATION 25 - ------------------------------------- HOW TO CONVERT YOUR INVESTMENT FROM ONE FIRST UNION FUND TO ANOTHER FIRST UNION FUND 19 - ------------------------------------- OTHER CLASSES OF SHARES 28 - ------------------------------------- ADDRESSES Inside Back Cover - ------------------------------------- - ------------------------ 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 15 portfolios, each representing a different First Union Fund. Each Single State Municipal Bond Fund currently offers three classes of shares: Class B Shares, Class C Shares, and Trust 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 B Shares), or (ii) on a contingent deferred basis (the Class C Shares). Trust 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 Single State Municipal Bond Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following five Single State Municipal Bond 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; and . 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. 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 B and Class C Shares of any of the Single State Municipal Bond 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 SINGLE STATE MUNICIPAL BOND FUNDS CLASS B SHARES
North South Florida Georgia Carolina Carolina Virginia Municipal Municipal Municipal Municipal Municipal Bond Fund Bond Fund Bond Fund Bond Fund Bond Fund CLASS B SHARES-- --------- --------- --------- --------- --------- SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Imposed on Purchases (as a percentage of offering price).... 4.00% 4.00% 4.00% 4.00% 4.00% Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)................................. None None None None None Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, as applicable)............... None None None None None Redemption Fee (as a percentage of amount redeemed, if applicable)......................... None None None None None Exchange Fee............................ None None None None None ANNUAL CLASS B SHARES OPERATING EXPENSES (As a percentage of projected average net assets) Management Fee (after waiver) (1)....... 0.00% 0.00% 0.16% 0.00% 0.00% 12b-1 Fees (2).......................... 0.25% 0.25% 0.25% 0.25% 0.25% Total Other Expenses (after waiver and reimbursement) (3)................. 0.37% 0.37% 0.38% 0.00% 0.37% Total Class B Shares Operating Ex- penses (4)............................. 0.62% 0.62% 0.79% 0.25% 0.62%
(1) The estimated management fees have been reduced to reflect the anticipated voluntary waivers by the Adviser. However, the North Carolina Municipal Bond Fund's management fee has been reduced to reflect the expected voluntary waiver 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 B Shares can pay up to 0.75% of Class B Shares' average daily net assets as a 12b-1 fee. For the foreseeable future, the Funds plan to limit the Class B Shares' 12b-1 payments to 0.25% of Class B Shares' average daily net assets. (3) Total Other Expenses for Florida, Georgia, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.73%, 2.17%, 2.71%, and 2.41%, respectively, absent the anticipated voluntary waiver by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The annual Class B Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bonds Funds were 0.25%, 0.25%, 0.32%, and 0.25%, respectively, for the period ended December 31, 1993. Total Class B Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds, absent the voluntary waivers and reimbursements of other operating expenses, were 1.83%, 6.82%, 1.25%, and 7.75%, respectively, for the period ended December 31, 1993. The annual Class B Shares operating expenses in the table above are based on estimated expenses expected during the fiscal year ending December 31, 1994. Total Class B Shares operating expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 1.48%, 2.92%, 1.13%, 3.46%, and 3.16%, respectively, absent the anticipated voluntary waivers and reimbursements described above in notes 1 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. Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charges 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. The Funds charge no redemption fees for Class B Shares. Florida Municipal Bond Fund................. $46 $59 N/A N/A Georgia Municipal Bond Fund................. $46 $59 N/A N/A North Carolina Municipal Bond Fund.......... $48 $64 $82 $134 South Carolina Municipal Bond Fund.......... $42 $48 N/A N/A Virginia Municipal Bond Fund................ $46 $59 N/A N/A
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 IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. - -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (CONTINUED) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS B SHARES 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 Trust Shares and Class C Shares. Trust Shares and Class C Shares are subject to certain of the same expenses as Class B Shares. However, Trust Shares bear no sales load or 12b-1 fee, and Class C Shares are subject to a 12b-1 fee of .75 of 1%, bear a maximum contingent deferred sales load of 4.00% and bear no front-end sales load. See "Other Classes of Shares." FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS C SHARES
Florida Georgia Municipal Municipal North Carolina Bond Fund Bond Fund Municipal Bond Fund ----------------------------- --------------------------- --------------------------- CLASS C 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 Deferred Sales Load (as 4% during the first year, 4% during the first year, 4% during the first year, a percentage of 3% during the second year, 3% during the second year, 3% during the second year, original purchase price 2.5% during the third year, 2.5% during the third year, 2.5% during the third year, or redemption proceeds, 2% during the fourth year, 2% during the fourth year, 2% during the fourth year, as applicable) (1)..... 1.5% during the fifth year, 1.5% during the fifth year, 1.5% during the fifth year, 0.5% during the sixth year, 0.5% during the sixth year, 0.5% during the sixth year, and 0% after the sixth year and 0% after the sixth year and 0% after the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable)............ None None None Exchange Fee............ None None None ANNUAL CLASS C SHARES (As a percentage of projected average net assets) Management Fee (after waiver) (2)............ 0.00% 0.00% 0.16% 12b-1 Fees.............. 0.75% 0.75% 0.75% Total Other Expenses (after waiver and reimbursement) (3)..... 0.37% 0.37% 0.38% Total Class C Shares Operating Expenses (4)...1.12% 1.12% 1.29%
- -------------------------- SUMMARY OF -------------------------- - -------------------------- FUND EXPENSES -------------------------- (CONTINUED) FIRST UNION SINGLE STATE MUNICIPAL BOND FUNDS CLASS C SHARES
South Carolina Virginia Municipal Municipal Bond Fund Bond Fund --------------------------- --------------------------- CLASS C SHARES--SHAREHOLDER TRANSACTION EXPENSES Maximum Sales Load Im- posed on Purchases (as a percentage of offer- ing price)............. None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price)........ None None Deferred Sales Load (as 4% during the first year, 4% during the first year, a percentage of 3% during the second year, 3% during the second year, original purchase price 2.5% during the third year, 2.5% during the third year, or redemption proceeds, 2% during the fourth year, 2% during the fourth year, as applicable) (1)..... 1.5% during the fifth year, 1.5% during the fifth year, 0.5% during the sixth year, 0.5% during the sixth year, and 0% after the sixth year and 0% after the sixth year Redemption Fee (as a percentage of amount redeemed, if applicable)............ 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% 0.00% 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver and reim- bursement) (3)......... 0.00% 0.37% Total Class C Shares Operating Expenses (4)................. 0.75% 1.12%
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than six 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 estimated management fees have been reduced to reflect the anticipated voluntary waivers by the Adviser. However, the North Carolina Municipal Bond Fund's management fee has been reduced to reflect the expected voluntary waiver 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, South Carolina, and Virginia Municipal Bond Funds are estimated to be 0.73%, 2.17%, 2.71% and 2.41%, respectively, absent the anticipated voluntary waiver by the administrator and reimbursement of other operating expenses by the Adviser. The administrator and Adviser may terminate these waivers and reimbursements at any time at their sole discretion. (4) The annual Class C Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds were 0.75%, 0.75%, 0.79%, and 0.75%, respectively, for the period ended December 31, 1993. Total Class C Shares operating expenses for Florida, Georgia, North Carolina, and Virginia Municipal Bond Funds, absent the voluntary waivers and reimbursements of other operating expenses, were 2.33%, 7.32%, 1.74%, and 8.25%, respectively, for the period ended December 31, 1993. The annual Class C Shares operating expenses in the table above are based on estimated expenses expected during the fiscal year ending December 31, 1994. Total Class C Shares operating expenses for Florida, Georgia, North Carolina, South Carolina, and Virginia Municipal Bond Funds are estimated to be 1.98%, 3.42%, 1.63%, 3.96%, and 3.66%, respectively, absent the anticipated 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 SINGLE STATE MUNICIPAL BOND FUNDS CLASS C SHARES Because of the asset-based sales charge, long-term shareholders may pay more than the economic equivalent of the maximum front-end sales charges 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................. $53 $64 N/A N/A Georgia Municipal Bond Fund................. $53 $64 N/A N/A North Carolina Municipal Bond Fund.......... $55 $69 $89 $156 South Carolina Municipal Bond Fund.......... $49 $52 N/A N/A Virginia Municipal Bond Fund................ $53 $64 N/A N/A You would pay the following expenses on the same investment, assuming no redemptions: Florida Municipal Bond Fund................. $11 $36 N/A N/A Georgia Municipal Bond Fund................. $11 $36 N/A N/A North Carolina Municipal Bond Fund.......... $13 $41 $71 $156 South Carolina Municipal Bond Fund.......... $ 8 $24 N/A N/A Virginia Municipal Bond Fund................ $11 $36 N/A N/A
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 IS BASED ON ESTIMATED DATA FOR THE FISCAL YEAR ENDING DECEMBER 31, 1994. The information set forth in the foregoing table and example relates only to Class C Shares of the Funds. The Funds also offer two additional classes of shares called Trust Shares and Class B Shares. Trust Shares and Class B Shares are subject to certain of the same expenses as Class C Shares. However, Trust Shares bear no sales load or 12b-1 fee, and Class B Shares are subject to a 12b-1 fee of .25 of 1%, bear a maximum front-end sales load of 4.00%, and bear no contingent deferred sales load. See "Other Classes of Shares." - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION FLORIDA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES(A) SHARES(A) ------------------ ------------------- PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993** - ------------------------------------- ------------------ ------------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ------------------------------------- Net investment income 0.22 0.20 - ------------------------------------- Net realized and unrealized gain 0.34 0.34 (loss) on investments ------ ------ - ------------------------------------- Total from investment operations 0.56 0.54 - ------------------------------------- LESS DISTRIBUTIONS - ------------------------------------- Dividends to shareholders from (0.22) (0.20) net investment income ------ ------ - ------------------------------------- NET ASSET VALUE, END OF PERIOD $10.34 $10.34 - ------------------------------------- ------ ------ TOTAL RETURN*** 5.63% 5.40% - ------------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------------- Expenses 0.25%(c) 0.75%(c) - ------------------------------------- Net investment income 4.92%(c) 4.46%(c) - ------------------------------------- Expense waiver/reimbursement (b) 1.58%(c) 1.58%(c) - ------------------------------------- SUPPLEMENTAL DATA - ------------------------------------- Net assets, end of period (000 omit- ted) $8,110 $18,383 - ------------------------------------- Portfolio turnover rate 3% 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. *** Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. (a) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION GEORGIA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES(A) SHARES(A) ------------------ ------------------ PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993* - ---------------------------------------- ------------------ ------------------ NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ---------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------------------------- Net investment income 0.201 0.179 - ---------------------------------------- Net realized and unrealized gain (loss) 0.193 0.193 on investments ------- ------- - ---------------------------------------- Total from investment operations 0.394 0.372 - ---------------------------------------- LESS DISTRIBUTIONS - ---------------------------------------- Dividends to shareholders from net in- vestment income (0.201) (0.179) - ---------------------------------------- Distributions to shareholders from net realized gain (0.003) (0.003) on investment transactions ------- ------- - ---------------------------------------- TOTAL DISTRIBUTIONS (0.204) (0.182) - ---------------------------------------- ------- ------- NET ASSET VALUE, END OF PERIOD $10.19 $10.19 - ---------------------------------------- ------ ------ TOTAL RETURN** 3.96% 3.74% - ---------------------------------------- RATIOS TO AVERAGE NET ASSETS - ---------------------------------------- Expenses 0.25%(c) 0.75%(c) - ---------------------------------------- Net investment income 4.71%(c) 4.15%(c) - ---------------------------------------- Expense waiver/reimbursement (b) 6.57%(c) 6.57%(c) - ---------------------------------------- SUPPLEMENTAL DATA - ---------------------------------------- Net assets, end of period (000 omitted) $817 $3,692 - ---------------------------------------- Portfolio turnover rate 15% 15% - ----------------------------------------
* 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) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. (c) Computed on an annualized basis. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial Statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES(B) SHARES(B) ------------------- ------------------- PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993** DECEMBER 31, 1993** - ------------------------------------- ------------------- ------------------- NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ------------------------------------- Net investment income 0.46 0.42 - ------------------------------------- Net realized and unrealized gain 0.64 0.64 (loss) on investments ------ ------ - ------------------------------------- Total from investment operations 1.10 1.06 - ------------------------------------- ------ ------ LESS DISTRIBUTIONS - ------------------------------------- Dividends to shareholders from net investment income (0.46) (0.42) - ------------------------------------- Distributions to shareholders from net realized gains (0.03) (0.03) on investment transactions ------ ------ - ------------------------------------- Total distributions (0.49) (0.45) - ------------------------------------- ------ ------ NET ASSET VALUE, END OF PERIOD $10.61 $10.61 - ------------------------------------- ------ ------ TOTAL RETURN* 11.28% 10.80% - ------------------------------------- RATIOS TO AVERAGE NET ASSETS - ------------------------------------- Expenses 0.32%(a) 0.79%(a) - ------------------------------------- Net investment income 4.91%(a) 4.47%(a) - ------------------------------------- Expense waiver/reimbursement (c) 0.93%(a) 0.95%(a) - ------------------------------------- SUPPLEMENTARY DATA - ------------------------------------- Net assets, end of period (000 omit- ted) $12,739 $45,168 - ------------------------------------- Portfolio turnover rate 57% 57% - -------------------------------------
* Based on net asset value, which does not reflect the sales load or contingent deferred sales charge, if applicable. ** Reflects operations for the period from January 11, 1993 (commencement of operations) to December 31, 1993. (a) Computed on an annualized basis. (b) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (c) This voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, which can be obtained free of charge. - ------------------------ FINANCIAL HIGHLIGHTS ------------------------ - ------------------------ ------------------------ FIRST UNION VIRGINIA MUNICIPAL BOND PORTFOLIO SUPPLEMENTARY INFORMATION (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD) The following table has been audited by KPMG Peat Marwick, the Fund's independent auditors. Their report, dated February 11, 1994, on the Fund's Financial statements for the year ended December 31, 1993, and on the following table for each of the periods presented, is included in the Trust's 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 Annual Report, which may be obtained from the Fund.
CLASS B CLASS C INVESTMENT INVESTMENT SHARES(A) SHARES(A) ------------------ ------------------ PERIOD ENDED PERIOD ENDED DECEMBER 31, 1993* DECEMBER 31, 1993* - ---------------------------------------- ------------------ ------------------ NET ASSET VALUE, BEGINNING OF PERIOD $10.00 $10.00 - ---------------------------------------- INCOME FROM INVESTMENT OPERATIONS - ---------------------------------------- Net investment income 0.20 0.17 - ---------------------------------------- Net realized and unrealized gain (loss) on 0.19 0.19 investments ------ ------ - ---------------------------------------- Total from investment operations 0.39 0.36 - ---------------------------------------- LESS DISTRIBUTIONS - ---------------------------------------- Dividends to shareholders from net in- vestment (0.20) (0.17) income ------ ------ - ---------------------------------------- NET ASSET VALUE, END OF PERIOD $10.19 $10.19 - ---------------------------------------- ------ ------ TOTAL RETURN** 3.89% 3.66% - ---------------------------------------- RATIOS TO AVERAGE NET ASSETS - ---------------------------------------- Expenses 0.25%(b) 0.75%(b) - ---------------------------------------- Net investment income 4.64%(b) 4.25%(b) - ---------------------------------------- Expense waiver/reimbursement (c) 7.50%(b) 7.50%(b) - ---------------------------------------- SUPPLEMENTARY DATA - ---------------------------------------- Net assets, end of period (000 omitted) $1,306 $2,235 - ---------------------------------------- Portfolio turnover rate 0% 0% - ----------------------------------------
* 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) Trust Shares were not being offered as of December 31, 1993. Accordingly, there are no Financial Highlights for such Shares. The Financial Highlights presented above are historical information for Class B and Class C Investment Shares. (b) Computed on an annualized basis. (c) The voluntary expense decrease is reflected in both the expenses and net investment income ratios shown above. Further information about the Fund's performance is contained in the Trust's Annual Report, dated December 31, 1993, 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. 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 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. 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 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 interest retains its tax-free status when distributed to the Fund's shareholders. In addition, at least 65% of the value of each Fund's total assets will be invested in municipal bonds of the particular state after which the Fund is named. 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 Fund seeks to achieve its investment objective by investing principally in municipal obligations, including industrial development bonds, of its designated state. 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 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 Funds will invest are subject to one or more of the following quality standards: rated Baa or better by Moody's Investors Service, Inc. ("Moody's") or BBB or better by Standard & Poor's Corporation ("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. 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. However, certain temporary investments will generate income which is subject to state taxes. 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. 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. - ------------------------ 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 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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 of the value of their total assets. 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 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. The Funds do not use these transactions for speculation or leverage. Options and futures may be volatile investments and involve certain risks which might result in lowering the Funds' returns. The three principal areas of risk include: (1) lack of a liquid secondary market for a futures or option contract when the Fund wants to close out its position; (2) imperfect correlation of changes in the prices of futures or options contracts with the prices of the securities in the Fund's portfolio; and (3) incorrect forecasts by the Adviser of interest rates, market values or other economic factors. In these events, the Funds may lose money on the futures contract or option. RESTRICTED AND ILLIQUID SECURITIES The Funds may not invest more than 15% of their total 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 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 its net assets. 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 a Fund may borrow up to one-third of the value of its total assets and pledge assets to secure such borrowings. NON-DIVERSIFICATION Each Fund 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 Fund 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. NEW ISSUERS The 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. - ------------------------ SHAREHOLDER GUIDE ------------------------ - ------------------------ ------------------------ CLASSES OF INVESTMENT SHARES You may select a method of purchasing Shares which is most beneficial to you by choosing either 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 two types of Investment 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 B Shares and Class C Shares is based on purchasing arrangements and distribution expenses. Class B Shares have a sales charge included at the time of purchase and are subject to a lower Rule 12b-1 distribution fee. This means that investors can purchase fewer Class B Shares for the same initial investment than Class C Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class C Shares impose a contingent deferred sales charge ("CDSC") on most redemptions made within six years of purchase and have higher distribution costs resulting from greater Rule 12b-1 distribution fees. This means that investors may purchase more Class C Shares than Class B 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 and the CDSC on Class C Shares would be less than the initial sales charge and accumulated Rule 12b-1 fee on Class B Shares purchased at the same time. Investors must also consider how that differential would be offset by the higher yield of Class B 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 B Shares adds an applicable sales charge, and the redemption proceeds of 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 Trust Shares may differ slightly from that of Class B Shares and Class C Shares of the same Fund due to the variability in daily net income resulting from different distribution charges 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 B Shares and Class C 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 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. 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 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 B Shares and Class C 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 B Shares, Class C Shares, and Trust Shares of a Fund. Because Class B Shares and Class C Shares are subject to 12b-1 fees, the yield and tax equivalent yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, Class C Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class C 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 B Shares), or (ii) on a contingent deferred basis (in the case of Class C Shares). MINIMUM INVESTMENT You may invest as often as you want in any of 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 B 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 4.00% 4.17% $ 100,000-$ 249,999 3.50% 3.63% $ 250,000-$ 499,999 2.50% 2.56% $ 500,000-$ 749,999 1.50% 1.52% $ 750,000-$ 999,999 1.00% 1.01% $1,000,000-$2,499,999 0.50% 0.50% $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 family, 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 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 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 six 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 4.0% Second 3.0% Third 2.5% Fourth 2.0% Fifth 1.5% Sixth 0.5% Seventh None
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 six 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 C 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 C Shares was accepted. At the end of this seven year period, Class C Shares may automatically convert to Class B Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class C 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 C 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 C Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class B Shares, Class C Shares purchased through the reinvestment of dividends and distributions paid on Class C Shares in a shareholder's Fund account will be considered to be held in a separate sub- account. Each time any Class C Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class B Shares, an equal pro rata portion of the Class C Shares in the sub-account will also convert to Class B 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 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, State Street Bank and Trust Company of Boston, Massachusetts ("State Street Bank") 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 B 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. 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 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their offering price determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 lose 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 C Shares will not be subject to a CDSC. However, if the shareholder redeems Class C Shares within six 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 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 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 State Street Bank, 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 the 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 WITHDRAWAL PLAN If you are a shareholder with an account valued at $10,000 or more, you may have amounts of $100 or more sent from your account to you on a regular monthly or quarterly basis. 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 $70.8 billion in total consolidated assets as of December 31, 1993. Through offices in 36 states and one foreign country, 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 $43.0 billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. 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. 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. From time to time, to the extent consistent with the objectives, policies and restrictions of the Funds, the Funds may invest in securities of issuers with which the Adviser has a lending relationship. 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 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 0.75% of the average daily net asset value of the Fund 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% for Class B Shares and 0.75% for Class C Shares of a 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 its distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of 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 C Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for 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"), 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 serves as custodian and 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 Single State Municipal Bond 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 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; 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, 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 3, 1994, FUBS, for the exclusive benefit of Robert Allen Jones and Larry Allen Jones of Florence, South Carolina, and for the exclusive benefit of Doris G. Foster and John H. Foster of Greenville, South Carolina, and acting in various capacities for numerous accounts, was the owner of record of 2,402 Shares (60.49%) and 1,493 Shares (37.59%), respectively, of the South Carolina Municipal Bond Fund--Class B Investment Shares, and therefore, may, for certain purposes, be deemed to control the South Carolina Municipal Bond 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. - ------------------------ 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 Funds 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 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 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 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 dividends to the extent that such dividends 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. To the extent that distributions from the Fund are attributable to capital gains or other sources, such distributions will not be exempt from South Carolina income taxation. 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 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 Single State Municipal Bond Funds offer three classes of shares: Class B Shares and Class C Shares for individuals and other customers of First Union and Trust Shares for institutional investors. Trust 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. Trust 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 B Shares and Class C Shares will be less than those payable to Trust Shares by the difference between distribution expenses borne by the shares of each respective class. - ------------------------ 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, Transfer Agent, and Dividend Disbursing Agent State Street Bank and Trust Company P.O. Box 8609 Boston, Massachusetts 02266-8609 - -------------------------------------------------------------------------------- Legal Counsel to the Independent Trustees Sullivan & Worcester 1025 Connecticut Ave., N.W. Washington, D.C. 20036 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- Federated Securities Corp., Distributor 3052402A (6/93) 533107 FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union North Carolina Municipal Bond Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-10 (9/94) FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union North Carolina Municipal Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 5 Restricted Securities 5 Portfolio Turnover 5 Investment Limitations 5 North Carolina Investment Risks 7 TRUST MANAGEMENT 8 - --------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 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 Plans (Class B and Class C Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 12 Use of Amortized Cost 12 Valuing Options 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- FINANCIAL STATEMENTS 15 - --------------------------------------------------------------- APPENDIX 16 - --------------------------------------------------------------- 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: Trust 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 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 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. 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 undertaking 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 disadantageous, 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 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 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 11, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rate for the Fund was 57%. 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 in excess of 5% of the value of its net assets during 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." 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 largely dependent on manufacturing and agriculture. In each area, the focus is narrow, with textiles and furniture dominating industry lines and eggs, poultry, and tobacco constituting the principal commodities. Manufacturing (particularly the textile industry), which continues to be far more important in North Carolina than in the nation, has been adversely affected by international competition. Tobacco farming continues to be affected by major federal legislation and regulatory measures, and by international competition. 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 the State's historical dependence on agriculture, textiles, and furniture manufacturing. 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. Financial operations for the State 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 reserves totaled $440 million at the end of fiscal 1993--equivalent to 6.1% of annual expenditures. Conservative revenue assumptions and sound budgeting practices should result in similar balances throughout the current biennium. The restoration of adequate reserve levels confirms the State's longstanding commitment to a sound financial position. As of December 31, 1993, general obligations of the State of North Carolina were rated Aaa/AAA/AAA by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation ("S&P") and Fitch Investors Service ("Fitch"), respectively. Both S&P and Fitch view the State's credit trend as "Stable." 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not being offered. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Thomas H. Wright III of Wilmington, North Carolina, owned approximately 89,475 Shares (6.98%); and FUBS, for the exclusive benefit of Wright Chemical Corporation of Wilmington, North Carolina, owned approximately 155,821 Shares (12.16%). As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $170,496, 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $48,493 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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 11, 1993 (commencement of operations) to December 31, 1993, brokers and administrators (financial institutions) did not receive any fees 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 Fund. 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' 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 cumulative total return for Class B Investment Shares and Class C Investment Shares from January 12, 1993 (start of performance) to December 31, 1993, were 6.79% and 6.63%, respectively. Trust Shares were not being offered during the period ended December 31, 1993. 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. The Fund's total return is representative of only eleven months of investment activity since the Fund's effective date. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Class B Investment Shares and Class C Investment Shares were 4.89% and 4.61%, respectively, for the thirty-day period ended December 31, 1993. Trust Shares were not being offered during the period ended December 31, 1993. 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 Class B Investment Shares and Class C Investment Shares for the thirty-day period ended December 31, 1993, were 6.79% and 6.40%, respectively, assuming a 28% tax rate and 7.09% and 6.68%, respectively, assuming a 31% tax rate. Trust Shares were not being offered during the period ended December 31, 1993. 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 1994 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- $38,001- $91,851- $100,001- $140,001- Over RETURN: 36,900 91,850 100,000 140,000 250,000 $ 250,000 SINGLE $1- $22,751- $55,101- $60,001- $140,001- Over RETURN: 22,750 55,100 60,000 140,000 250,000 $ 250,000 - ------------------------------------------------------------------------------------------ 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 Fund for the purposes of the North Carolina intangible personal property tax that proportion 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 Fund 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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union North Carolina Municipal Bond Portfolio for the fiscal year ended December 31, 1993, are incorporated herein by reference from the Trust's Annual Report dated December 31, 1993 (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 CORPORATION MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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. 3031004B (2/94) FIRST UNION FLORIDA MUNICIPAL BOND PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Florida Municipal Bond Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-08 (9/94) FIRST UNION FLORIDA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Florida Municipal Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 5 Restricted Securities 5 Portfolio Turnover 5 Investment Limitations 5 Florida Investment Risks 7 TRUST MANAGEMENT 8 - --------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 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 Plans (Class B and Class C Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 12 Use of Amortized Cost 12 Valuing Options 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 16 - --------------------------------------------------------------- FINANCIAL STATEMENTS 17 - --------------------------------------------------------------- APPENDIX 18 - --------------------------------------------------------------- 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: Trust 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 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 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. 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 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 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 July 2, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rate for the Fund was 3%. 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 in excess of 5% of the value of its net assets during 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." 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director; Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not effective. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Enrique Lavernia and Nidia Lavernia of Boca Raton, Florida, owned approximately 73,611 Shares (8.21%); FUBS, for the exclusive benefit of Ivan Lavernia and Nadina Lavernia of Lighthouse Point, Florida, owned approximately 53,782 Shares (6.00%); FUBS, for the exclusive benefit of Lisa L. Speer Trust, Richard W. Baker, Trustee, of Holiday, Florida, owned approximately 65,000 Shares (7.25%); and FUBS, for the exclusive benefit of Frank M. Patti of Pensacola, Florida, owned approximately 51,895 Shares (5.79%). As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $31,835, 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. 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 July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $24,932 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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 July 2, 1993 (commencement of operations) to December 31, 1993, brokers and administrators (financial institutions) received fees in the amount of $39,925 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 Fund. 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' 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 cumulative total return for Class B Investment Shares from July 5, 1993 (start of performance) to December 31, 1993, was 1.38%. The Fund's cumulative total return for Class C Investment Shares from July 1, 1993 (start of performance) to December 31, 1993, was 1.34%. Trust Shares were not effective during the period ended December 31, 1993. 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. The Fund's total return is representative of only six months of investment activity since the Fund's effective date. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Class B Investment Shares and Class C Investment Shares were 4.85% and 4.57%, respectively, for the thirty-day period ended December 31, 1993. Trust Shares were not effective during the period ended December 31, 1993. 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 Class B Investment Shares and Class C Investment Shares for the thirty-day period ended December 31, 1993, were 6.74% and 6.35%, respectively, assuming a 28% tax rate and 7.03% and 6.62%, respectively, assuming a 31% tax rate. Trust Shares were not effective during the period ended December 31, 1993. 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 1994 STATE OF FLORIDA - -------------------------------------------------------------------------------- TAX-FREE YIELD--4.00% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 4.71% 19.25% 4.95% 28.00 5.56 31.60 5.85 31.00 5.80 34.45 6.10 36.00 6.25 39.20 6.58 39.60 6.62 42.62 6.97 - -------------------------------------------------------------------------------- TAX-FREE YIELD--4.50% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 5.29% 18.78% 5.54% 28.00 6.25 31.20 6.54 31.00 6.52 34.07 6.83 36.00 7.03 38.84 7.36 39.60 7.45 42.28 7.80 - -------------------------------------------------------------------------------- TAX-FREE YIELD--5.00% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 5.88% 18.40% 6.13% 28.00 6.94 30.88 7.23 31.00 7.25 33.76 7.55 36.00 7.81 38.56 8.14 39.60 8.28 42.02 8.62 - -------------------------------------------------------------------------------- TAX-FREE YIELD--5.50% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 6.47% 18.09% 6.71% 28.00 7.64 30.62 7.93 31.00 7.97 33.51 8.27 36.00 8.59 38.33 8.92 39.60 9.11 41.80 9.45 - -------------------------------------------------------------------------------- TAX-FREE YIELD--6.00% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 7.06% 17.83% 7.30% 28.00 8.33 30.40 8.62 31.00 8.70 33.30 9.00 36.00 9.38 38.13 9.70 39.60 9.93 41.61 10.28 - -------------------------------------------------------------------------------- TAX-FREE YIELD--6.50% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 7.65% 17.62% 7.89% 28.00 9.03 30.22 9.31 31.00 9.42 33.12 9.72 36.00 10.16 37.97 10.48 39.60 10.76 41.46 11.10 - -------------------------------------------------------------------------------- TAX-FREE YIELD--7.00% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 8.24% 17.43% 8.48% 28.00 9.72 30.06 10.01 31.00 10.14 32.97 10.44 36.00 10.94 37.83 11.26 39.60 11.59 41.33 11.93 - -------------------------------------------------------------------------------- TAX-FREE YIELD--7.50% - -------------------------------------------------------------------------------- FEDERAL FEDERAL AND AND FEDERAL FEDERAL INTANGIBLES INTANGIBLES TAX TAXABLE COMBINED TAXABLE BRACKET OF EQUIVALENT TAX RATE* EQUIVALENT - -------------------------------------------------------------------------------- 15.00% 8.82% 17.27% 9.07% 28.00 10.42 29.92 10.70 31.00 10.87 32.84 11.17 36.00 11.72 37.71 12.04 39.60 12.42 41.21 12.76
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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Florida Municipal Bond Portfolio for the fiscal year ended December 31, 1993, are incorporated herein by reference from the Trust's Annual Report, dated December 31, 1993 (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 CORPORATION MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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. 3031209B (2/94) FIRST UNION GEORGIA MUNICIPAL BOND PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Georgia Municipal Bond Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-09 (9/94) FIRST UNION NORTH CAROLINA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union North Carolina Municipal Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 5 Restricted Securities 5 Portfolio Turnover 5 Investment Limitations 5 North Carolina Investment Risks 7 TRUST MANAGEMENT 8 - --------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 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 Plans (Class B and Class C Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 12 Use of Amortized Cost 12 Valuing Options 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- FINANCIAL STATEMENTS 15 - --------------------------------------------------------------- APPENDIX 16 - --------------------------------------------------------------- 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: Trust 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 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 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. 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 undertaking 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 disadantageous, 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 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 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 11, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rate for the Fund was 57%. 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 in excess of 5% of the value of its net assets during 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." 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 largely dependent on manufacturing and agriculture. In each area, the focus is narrow, with textiles and furniture dominating industry lines and eggs, poultry, and tobacco constituting the principal commodities. Manufacturing (particularly the textile industry), which continues to be far more important in North Carolina than in the nation, has been adversely affected by international competition. Tobacco farming continues to be affected by major federal legislation and regulatory measures, and by international competition. 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 the State's historical dependence on agriculture, textiles, and furniture manufacturing. 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. Financial operations for the State 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 reserves totaled $440 million at the end of fiscal 1993--equivalent to 6.1% of annual expenditures. Conservative revenue assumptions and sound budgeting practices should result in similar balances throughout the current biennium. The restoration of adequate reserve levels confirms the State's longstanding commitment to a sound financial position. As of December 31, 1993, general obligations of the State of North Carolina were rated Aaa/AAA/AAA by Moody's Investors Service, Inc. ("Moody's"), Standard & Poor's Corporation ("S&P") and Fitch Investors Service ("Fitch"), respectively. Both S&P and Fitch view the State's credit trend as "Stable." 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not being offered. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Thomas H. Wright III of Wilmington, North Carolina, owned approximately 89,475 Shares (6.98%); and FUBS, for the exclusive benefit of Wright Chemical Corporation of Wilmington, North Carolina, owned approximately 155,821 Shares (12.16%). As of February 4, 1994, no shareholders of record owned 5% or more of the outstanding Class C Investment Shares of the Fund. 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 (the "Adviser") is First Union National Bank of North Carolina. 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $170,496, 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. 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 11, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $48,493 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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 11, 1993 (commencement of operations) to December 31, 1993, brokers and administrators (financial institutions) did not receive any fees 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 Fund. 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' 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 cumulative total return for Class B Investment Shares and Class C Investment Shares from January 12, 1993 (start of performance) to December 31, 1993, were 6.79% and 6.63%, respectively. Trust Shares were not being offered during the period ended December 31, 1993. 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. The Fund's total return is representative of only eleven months of investment activity since the Fund's effective date. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Class B Investment Shares and Class C Investment Shares were 4.89% and 4.61%, respectively, for the thirty-day period ended December 31, 1993. Trust Shares were not being offered during the period ended December 31, 1993. 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 Class B Investment Shares and Class C Investment Shares for the thirty-day period ended December 31, 1993, were 6.79% and 6.40%, respectively, assuming a 28% tax rate and 7.09% and 6.68%, respectively, assuming a 31% tax rate. Trust Shares were not being offered during the period ended December 31, 1993. 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 1994 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- $38,001- $91,851- $100,001- $140,001- Over RETURN: 36,900 91,850 100,000 140,000 250,000 $ 250,000 SINGLE $1- $22,751- $55,101- $60,001- $140,001- Over RETURN: 22,750 55,100 60,000 140,000 250,000 $ 250,000 - ------------------------------------------------------------------------------------------ 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 Fund for the purposes of the North Carolina intangible personal property tax that proportion 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 Fund 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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union North Carolina Municipal Bond Portfolio for the fiscal year ended December 31, 1993, are incorporated herein by reference from the Trust's Annual Report dated December 31, 1993 (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 CORPORATION MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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. 3031004B (2/94) FIRST UNION VIRGINIA MUNICIPAL BOND PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union Virginia Municipal Bond Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-12 (9/94) FIRST UNION VIRGINIA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union Virginia Municipal Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994 [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 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 5 Restricted Securities 5 Portfolio Turnover 5 Investment Limitations 5 Virginia Investment Risks 7 TRUST MANAGEMENT 8 - --------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 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 Plans (Class B and Class C Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 12 Use of Amortized Cost 12 Valuing Options 12 REDEEMING SHARES 12 - --------------------------------------------------------------- Redemption in Kind 12 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 13 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 14 - --------------------------------------------------------------- FINANCIAL STATEMENTS 15 - --------------------------------------------------------------- APPENDIX 16 - --------------------------------------------------------------- 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: Trust 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 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 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. 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 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 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 July 2, 1993 (commencement of operations) to December 31, 1993, the portfolio turnover rate for the Fund was 0%. 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 in excess of 5% of the value of its net assets during 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." 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 is based on improving economic forecasts with projected job growth of 1.9%/year overall, and 3.8% in service-related sectors. 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. A State budget surplus in 1993 has left funds available for reserves and appropriations. Revenue growth for 1993-1994 is expected to be 4%. 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 5.1% (as of August, 1993) is well below the national rate of 6.7%, 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not effective. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Duff M. Green of Fredericksburg, Virginia, owned approximately 19,757 Shares (14.46%); FUBS, for the exclusive benefit of Sookja Lee and Jungha Lee of Fairfax, Virginia, owned approximately 7,805 Shares (5.71%); FUBS, for the exclusive benefit of Theresa C. Watson and Catharine M. O'Hara of Alexandria, Virginia, owned approximately 7,729 Shares (5.66%); FUBS, for the exclusive benefit of Drahomira Dosoudil of Alexandria, Virginia, owned approximately 8,811 Shares (6.45%); FUBS, for the exclusive benefit of Carroll J. Austin and Teresa M. Austin of Singapore, owned approximately 8,137 Shares (5.96%); FUBS, for the exclusive benefit of Louis F. Herrmann and Vicki R. Herrmann of McLean, Virginia, owned approximately 8,452 Shares (6.19%); and FUBS, for the exclusive benefit of Judith Z. Watson of Spring Fall, Virginia, owned approximately 11,382 Shares (8.33%). As of February 4, 1994, 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 Harry S. Williams and Patsy Williams of Marion, Virginia, owned approximately 19,892 Shares (7.35%); and FUBS, for the exclusive benefit of John L. Zepp and Mary Lou Zepp of Vienna, Virginia, owned approximately 22,579 Shares (8.34%). 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 (the "Adviser") is First Union National Bank of North Carolina. 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. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. For the period from July 2, 1993 (commencement of operations) to December 31, 1993, the Adviser earned advisory fees of $4,283, 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. 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 July 2, 1993 (commencement of operations) to December 31, 1993, the Fund incurred $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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. 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 July 2, 1993 (commencement of operations) to December 31, 1993, brokers and administrators (financial institutions) received fees in the amount of $4,593 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 Fund. 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' 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 cumulative total return for Class B Investment Shares from July 7, 1993 (start of performance) to December 31, 1993, was (.30%). The Fund's cumulative total return for Class C Investment Shares from July 1, 1993 (start of performance) to December 31, 1993, was (.39%). Trust Shares were not effective during the period ended December 31, 1993. 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. The Fund's total return is representative of only six months of investment activity since the Fund's effective date. YIELD - -------------------------------------------------------------------------------- The Fund's yields for Class B Investment Shares and Class C Investment Shares were 4.77% and 4.47%, respectively, for the thirty-day period ended December 31, 1993. Trust Shares were not effective during the period ended December 31, 1993. 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 Class B Investment Shares and Class C Investment Shares for the thirty-day period ended December 31, 1993, were 7.20% and 6.75%, 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. Trust Shares were not effective during the period ended December 31, 1993. 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 1994 STATE OF VIRGINIA - ------------------------------------------------------------------------------- COMBINED FEDERAL AND STATE INCOME TAX BRACKET: 20.75% 33.75% 36.75% 41.75% 45.35% - ------------------------------------------------------------------------------- JOINT $1- $38,001- $91,851- $140,001- Over RETURN: 38,000 91,850 140,000 250,000 $ 250,000 SINGLE $1- $22,751- $55,101- $140,001- Over RETURN: 22,750 55,100 140,000 250,000 $ 250,000 - -------------------------------------------------------------------------------
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 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. FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- The financial statements for First Union Virginia Municipal Bond Portfolio for the fiscal year ended December 31, 1993, are incorporated herein by reference from the Trust's Annual Report dated December 31, 1993 (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 CORPORATION MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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. 3031208B (2/94) FIRST UNION SOUTH CAROLINA MUNICIPAL BOND PORTFOLIO (A PORTFOLIO OF FIRST UNION FUNDS) TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES Supplement to Combined Statement of Additional Information dated February 28, 1994 Effective September 1, 1994, First Union South Carolina Municipal Bond Portfolio (the "Fund") will offer Class D Investment Shares ("Class D Shares"). Class D Shares will be similar to Class C Shares in all respects except: Class D Shares will have a contingent deferred sales charge of 1.00%, which terminates after one year, and the Class D Shares will not automatically convert into Class B Shares after seven years. Effective September 1, 1994, Class C Shares will assess a shareholder service fee of 0.25% of the average daily net asset value, of which all or a portion may be waived at any time. September 1, 1994 FEDERATED SECURITIES CORP. Distributor G00389-11 (9/94) FIRST UNION SOUTH CAROLINA MUNICIPAL BOND PORTFOLIO A PORTFOLIO OF FIRST UNION FUNDS TRUST 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 Trust Shares, Class B Investment Shares, or Class C Investment Shares for First Union South Carolina Municipal Bond Portfolio, dated February 28, 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 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, 1994. [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 2 Futures and Options Transactions 2 Repurchase Agreements 4 Reverse Repurchase Agreements 4 Lending of Portfolio Securities 5 Restricted Securities 5 Portfolio Turnover 5 Investment Limitations 5 South Carolina Investment Risks 7 TRUST MANAGEMENT 8 - --------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 10 - --------------------------------------------------------------- Adviser to the Fund 10 Advisory Fees 10 BROKERAGE TRANSACTIONS 10 - --------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - --------------------------------------------------------------- PURCHASING SHARES 11 - --------------------------------------------------------------- Distribution Plans (Class B and Class C Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - --------------------------------------------------------------- Valuing Municipal Bonds 12 Use of Amortized Cost 12 Valuing Options 12 REDEEMING SHARES 13 - --------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - --------------------------------------------------------------- YIELD 14 - --------------------------------------------------------------- TAX EQUIVALENT YIELD 14 - --------------------------------------------------------------- Tax Equivalency Table 14 PERFORMANCE COMPARISONS 15 - --------------------------------------------------------------- APPENDIX 16 - --------------------------------------------------------------- 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: Trust 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 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 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. 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 The Fund engages in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with the Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price and yield for the Fund. 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. No fees or 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 securities are marked to market daily and maintained until the transaction is settled. The Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 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. FINANCIAL FUTURES CONTRACTS A futures contract is a firm commitment by two parties, the seller who agrees to make delivery of the specific type of security called for in the contract ("going short") and the buyer who agrees to take delivery of the security ("going long") at a certain time in the future. Financial futures contracts call for the delivery of particular debt securities issued or guaranteed by the U.S. Treasury or by specified agencies or instrumentalities of the U.S. government. In the fixed income securities market, price moves inversely to interest rates. A rise in rates means a drop in price. Conversely, a drop in rates means a rise in price. In order to hedge its holdings of fixed income securities against a rise in market interest rates, the Fund could enter into contracts to deliver securities at a predetermined 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. The Fund would "go long" (agree to purchase securities in the future at a predetermined price) to hedge against a decline in market interest rates. PURCHASING PUT OPTIONS ON FINANCIAL FUTURES CONTRACTS The Fund may purchase listed 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 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 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 write covered put and call options to generate income. As writer of a call option, the Fund has the obligation upon exercise of the option during the option period to deliver the underlying security upon payment of the exercise price. As a writer of a put option, the Fund has the obligation to purchase a security from the purchaser of the option upon the exercise of the option. The Fund may only write call options either on securities held in its portfolio or on securities which it has the right to obtain without payment of further consideration (or has segregated cash in the amount of any additional consideration). In the case of put options, the Fund will segregate cash or U.S. Treasury obligations with a value equal to or greater than the exercise price of the underlying securities. 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 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 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%. 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 in excess of 5% of the value of its net assets during 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". 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 Corporation ("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. Several lawsuits have been filed against the State, asserting that the decision in Davis v. Michigan Department of Treasury, 489 U.S. 803 (1989), invalidates the State's tax treatment of federal retirement benefits for years before 1989. Under the State's applicable statute of limitation, the State estimates that its maximum potential liability under those suits is approximately $200 million. The plaintiffs in those suits, however, may request funds for periods that the State believes are closed under the applicable statute of limitation, and those refund requests, if ultimately granted, could result in liability for the State in excess of the amounts indicated above. Any such liability would be predicated on a holding by a State court or the United States Supreme Court that the Davis decision is applicable to the State's prior method of taxing federal retirement benefits and that the Davis decision is to be given retroactive effect. The effects of the most recent military base-closing and consolidation legislation will be pronounced for several sections of South Carolina, most particularly in the Charleston area, where the cutbacks were large and represented a not insignificant percentage of total economic activity. Another round of military base-closings is scheduled for 1995, which may further impact South Carolina. 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. TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Federated Investors, Federated Securities Corp., or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, President and Treasurer, Federated Advisers, Federated Management, and and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; 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 Vice President Vice President, Federated Administrative Services; Director, Private and Assistant Label Management, Federated Investors; Vice President and Assistant Treasurer Treasurer of certain investment companies for which Federated Securities Corp. is the principal distributor. Peter J. Germain Secretary Corporate Counsel, Federated Investors.
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. As of February 4, 1994, Trust Shares of the Fund were not effective. As of February 4, 1994, the following shareholders of record owned 5% or more of the outstanding Class B Investment Shares of the Fund: First Union Brokerage Services & Co. ("FUBS"), for the exclusive benefit of Robert Allen Jones and Larry Allen Jones of Florence, South Carolina, owned approximately 2,402 Shares (60.49%); and FUBS, for the exclusive benefit of Doris G. Foster and John H. Foster of Greenville, South Carolina, owned approximately 1,493 Shares (37.59%). As of February 4, 1994, 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 Patricia B. Stokes of Florence, South Carolina, owned approximately 3,003 Shares (5.79%); FUBS, for the exclusive benefit of James M. Inabinette and Lena C. Inabinette of West Columbia, South Carolina, owned approximately 7,200 Shares (13.88%); FUBS, for the exclusive benefit of Mollie L. Fogle of Orangeburg, South Carolina, owned approximately 6,199 Shares (11.95%); FUBS, for the exclusive benefit of Jimmie D. Evans of Cayce, South Carolina, owned approximately 3,999 Shares (7.71%); FUBS, for the exclusive benefit of Betty C. Gonzalez of Columbia, South Carolina, owned approximately 2,650 Shares (5.11%); FUBS, for the exclusive benefit of Dorothy H. Campbell of Greenville, South Carolina, owned approximately 2,784 Shares (5.37%); FUBS, for the exclusive benefit of James R. Lingle and Elizabeth W. Lingle of Florence, South Carolina, owned approximately 4,972 Shares (9.58%); and FUBS, for the exclusive benefit of John Edgar Lockman Senior Trust, Dianne Lockman Price, Trustee, of Liberty, South Carolina, owned approximately 4,469 Shares (8.61%). 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 (the "Adviser") is First Union National Bank of North Carolina. 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. ADVISORY FEES For its advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. 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. 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. 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 B 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 3.50%, not 4.00%. 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 4.0% 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 B AND CLASS C INVESTMENT SHARES) With respect to the 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 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 B and Class C Investment Shares and (ii) stimulate administrators to render administrative support services to the Fund and holders of 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 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 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. 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 financial institutions may be required to register as dealers pursuant to state law. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. 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. 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' 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 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. YIELD - -------------------------------------------------------------------------------- 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 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 1994 STATE OF SOUTH CAROLINA - -------------------------------------------------------------------------------
COMBINED FEDERAL AND STATE INCOME TAX BRACKET: 22.00% 35.00% 38.00% 43.00% 46.60% - ------------------------------------------------------------------------------- JOINT $1- $38,001- $91,851 $140,001 Over RETURN: 38,000 91,850 140,000 250,000 $ 250,000 SINGLE $1- $22,751- $55,101 $115,001 Over RETURN: 22,750 55,100 115,000 250,000 $ 250,000 - ------------------------------------------------------------------------------- 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 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. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S CORPORATION MUNICIPAL BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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. 3092402B (2/94) - --------------------- FIRST UNION --------------------- - --------------------- INTERNATIONAL --------------------- FUNDS Portfolios of First Union Funds TRUST SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S September , 1994 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes two diversified International Funds, seven diversified Equity and Income Funds, three diversified Money Market Funds, and five non-diversified Single State Municipal Bond Funds. They are: International Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Equity and Income Funds . First Union Balanced Portfolio; . First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio; . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and . First Union Value Portfolio. Money Market Funds . First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and . First Union Treasury Money Market Portfolio. Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. This prospectus provides you with information specific to the Trust Shares of First Union International Funds. It concisely describes the information which you should know before investing in Trust Shares of any of the First Union International Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union International Fund in the Combined Statement of Additional Information, dated September , 1994, 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 value of investment company shares offered by this prospectus fluctuates daily. 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 15 - ------------------------------------- ------------------------------------- Summary of Fund Expenses 4 Management of First Union Funds 16 - ------------------------------------- ------------------------------------- Investment Objectives and Policies 5 Fees and Expenses 18 - ------------------------------------- ------------------------------------- First Union Emerging Markets Growth Shareholder Rights and Privileges 20 Portfolio 5 ------------------------------------- - ------------------------------------- Distributions and Taxes 22 First Union International Equity ------------------------------------- Portfolio 6 - ------------------------------------- Tax Information 22 ------------------------------------- Types of Investments 6 - ------------------------------------- Other Classes of Shares 23 ------------------------------------- Other Investment Policies 7 - ------------------------------------- Addresses Inside Back Cover ------------------------------------- Shareholder Guide 12 - ------------------------------------- How to Buy Shares 13 - ------------------------------------- How to Convert Your Investment from One First Union Fund to Another First Union Fund 14 - ------------------------------------- - ------------------------ 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 International Fund is divided into four classes of shares: Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares"), Class D Investment Shares ("Class D Shares") and Trust Shares. Trust Shares are designed primarily for institutional investors (banks, corporations, and fiduciaries). Class B, Class C, and Class D Shares are sold to individuals and other customers of First Union (the "Adviser"). This prospectus relates only to Trust Shares ("Shares") of First Union International Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Shares are offered in the following two Funds: . First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund")--seeks to produce long-term capital appreciation The Emerging Markets Growth Fund invests in equity securities of emerging Market issuers; 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 Trust 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 INTERNATIONAL FUNDS TRUST SHARES
Emerging International Markets Growth Equity Fund Fund -------------- ------------- Trust Shares--Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price).............. None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).............. None None Contingent Deferred Sales Charge (as a percentage 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 Trust Shares Operating Expenses* (As a percentage of projected average net assets) Management Fee (after waiver) (1)................. % % 12b-1 Fees........................................ None None Total Other Expenses (after waiver) (2)........... % % Total Trust Shares Operating Expenses (3)....... % %
(1) 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. (2) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the anticipated voluntary waiver by the administrator. The administrator may terminate these voluntary waivers at any time at its sole discretion. (3) Total Trust Shares Operating Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the voluntary waivers 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, 1994. 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 Trust Shares. Emerging Markets Growth Fund.................................. $-- $-- International Equity Fund..................................... $-- $--
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, 1994. The information set forth in the foregoing table and example relates only to Trust Shares of the Funds. The Funds also offer three additional classes of shares called Class B Shares, Class C Shares, and Class D Shares. In general, all expenses are allocated based upon daily net assets of each class Class B Shares, Class C Shares, and Class D Shares are subject to certain of the same expenses as Trust Shares. However, Class B Shares are subject to a 12b-1 fee of 0.25 of 1% and Class C Shares and Class D 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 B Shares bear a maximum front-end sales charge of 4.75%, Class C Shares bear a maximum contingent deferred sales charge of 5.00% and Class D Shares bear a maximum contingent deferred sales charge of 1.00%. See "Other Classes of Shares." - ------------------------- INVESTMENT ------------------------- - ------------------------- OBJECTIVES ------------------------- AND POLICIES First Union International 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. The Fund focuses on equity securities, but may also invest in other types of instruments, including debt securities. - ------------------------- 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 the Adviser and Boston International, the Sub- Adviser to the Fund, determine, 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. 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 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 Corporation ("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; 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; 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 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 or Sub-Advisers 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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 Fund's 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 Adviser or each Sub-Adviser will consider the likelihood of changes in currency values when making investment decisions, the Adviser or 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 Fund's assets denominated in that currency. OPTIONS AND FUTURES The Funds may deal in options on foreign currencies, and securities indices, 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 Adviser or 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 Adviser's or 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 the Adviser or 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 in the Statement of Additional Information, 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 securities. 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. 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. 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 (NAV), 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 Trust Shares of a Fund may differ slightly from that of Class B Shares, Class C Shares and Class D 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 C Shares and Class D 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 or 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 Trust 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 Trust 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 Trust 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 Trust Shares, Class B Shares, Class C Shares and Class D Shares of a Fund. Because Class B Shares are subject to 12b-1 fees, and Class C Shares and Class D Shares are subject to a 12b-1 fee and a shareholder services fee, the yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, Class C Shares and Class D 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 C Shares and Class D 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 any of the Funds. There are no sales charges imposed on Trust 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 Trust 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 Trust Shares of one First Union Fund for Trust 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their net asset value determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 $ billion in total consolidated assets as of June 30, 1994. Through offices in 36 states and one foreign country, 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 $ billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of their 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 leading 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 these 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 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 holders. 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 $ billion in investments for 32 institutional investors. As of June 30, 1994, Marvin & Palmer served as investment Adviser or Sub- Adviser to other investment company with total assets of $32.6 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 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 and Portfolio Manager of the Sub-Adviser. Before joining the Sub-Adviser in 1990, Mr. Mason was employed for 14 years by DuPont Corporation, the last five as International Equity Analyst and 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 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 twenty international portfolios, including five group trust funds, for pensions and endowment plans 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 $ billion in assets under management. In addition, as of June 30, 1994, Boston International served as investment adviser or sub-adviser to one other investment company with total assets of $146.4 million. Maureen Ghublikian has been a Managing Director of the Sub-Adviser since the firm's inception in 1986. In 1986, she was promoted to Vice President. Ms. Ghublikian has served as co-portfolio manager of the Fund since its inception in September 1994. David A. Umstead has been a founder and 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., 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"), 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 ("State Street Bank"), Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 objectives and policies. For its services under the Sub-Advisory Contract, 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 TRUST 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 by the Class B Shares, Class C Shares and Class D Shares. In addition, the Funds' expenses under the Shareholder Services Plan are incurred by the Class C Shares and Class D 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 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. - ------------------------- 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 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 International Funds offer four classes of shares: Trust Shares for institutional investors and Class B Shares, Class C Shares and Class D Shares for individuals and other customers of First Union. Class B Shares, Class C Shares and Class D Shares of First Union International 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 B Shares), or (ii) on a contingent deferred basis (the Class C Shares and Class D Shares). Shareholders of record in any Fund at October 12, 1990, and the members of their immediate family, 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. Class B Shares, Class C Shares and Class D Shares are distributed pursuant to Rule 12b-1 Plans adopted by the Trust, whereby the distributor is paid a fee of .25 of 1% for Class B Shares and .75 of 1% for Class C Shares and Class D Shares of each Fund's average daily net asset value. In addition, Class C Shares and Class D Shares pay a shareholder services fee of .25 of 1% of the respective 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 B Shares, Class C Shares, and Class D Shares will be less than those payable to Trust Shares by the difference between class expenses and distribution and shareholder service expenses borne by the shares of each respective class. - ------------------------- 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 Fund Marvin & Palmer Associates, Inc. One Commerce Center Suite 1100 Wilmington, Delaware 19801 - -------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- - ------------------------ FIRST UNION ------------------------ - ------------------------ INTERNATIONAL ------------------------ FUNDS Portfolios of First Union Funds CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES CLASS D INVESTMENT SHARES - -------------------------------------------------------------------------------- P R O S P E C T U S September , 1994 First Union Funds (the "Trust") is a mutual fund with 17 portfolios, offering a variety of investment opportunities. The Trust currently includes two diversified International Funds, seven diversified Equity and Income Funds, three diversified Money Market Funds, and five non-diversified Single State Municipal Bond Funds. They are: International Funds . First Union Emerging Markets Growth Portfolio; and . First Union International Equity Portfolio. Equity and Income Funds .First Union Balanced Portfolio; .First Union Fixed Income Portfolio; . First Union High Grade Tax Free Portfolio (formerly, First Union Insured Tax Free Portfolio); . First Union Managed Bond Portfolio (Investment Shares not currently offered); . First Union U.S. Government Portfolio; . First Union Utility Portfolio; and .First Union Value Portfolio. Money Market Funds .First Union Money Market Portfolio; . First Union Tax Free Money Market Portfolio; and .First Union Treasury Money Market Portfolio. Single State Municipal Bond 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; and . First Union Virginia Municipal Bond Portfolio. This prospectus provides you with information specific to the Class B Investment Shares ("Class B Shares"), Class C Investment Shares ("Class C Shares"), and Class D Investment Shares ("Class D Shares") of First Union International Funds. It concisely describes the information which you should know before investing in Class B Shares, Class C Shares or Class D Shares of any of the First Union International Funds. Please read this prospectus carefully and keep it for future reference. You can find more detailed information about each First Union International Fund in the Combined Statement of Additional Information, dated September , 1994, 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 value of investment company shares offered by this prospectus fluctuates daily. 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 17 - -------------------------------------- -------------------------------------- Summary of Fund Expenses 4 Additional Shareholder Services 17 - -------------------------------------- -------------------------------------- Investment Objectives and Policies 7 Management of First Union Funds 18 - -------------------------------------- -------------------------------------- First Union Emerging Markets Growth Fees and Expenses 20 Portfolio 7 -------------------------------------- - -------------------------------------- Shareholder Rights and Privileges 22 First Union International Equity -------------------------------------- Portfolio 7 - -------------------------------------- Distributions and Taxes 23 -------------------------------------- Types of Investments 8 - -------------------------------------- Tax Information 23 -------------------------------------- Other Investment Policies 8 - -------------------------------------- Other Classes of Shares 24 -------------------------------------- Shareholder Guide 12 - -------------------------------------- Addresses Inside Back Cover -------------------------------------- How to Buy Shares 14 - -------------------------------------- How to Convert Your Investment from One First Union Fund to Another First Union Fund 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 International Fund is divided into four classes of shares: Class B Shares, Class C Shares, Class D Shares and Trust Shares. Class B, Class C, and Class D 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 B Shares), or (ii) on a contingent deferred basis (the Class C and Class D Shares). Trust 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 International Funds (collectively, the "Funds"). THE FUNDS AND OBJECTIVES As of the date of this prospectus, Class B, Class C, and Class D Shares are offered in the following two Funds: . First Union Emerging Markets Growth Portfolio ("Emerging Markets Growth Fund")--seeks to produce long-term capital appreciation. The Emerging Markets Growth Fund invests in equity securities of emerging market issuers; 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 B, Class C, and Class D 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 INTERNATIONAL FUNDS CLASS B SHARES
Emerging Markets Growth International Fund Equity Fund -------------- ------------- Class B 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 percentage of offering price).............. None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption pro- ceeds, as applicable)............................ None None Redemption Fee (as a percentage of amount re- deemed, if applicable)........................... None None Exchange Fee...................................... None None Annual Class B Shares Operating Expenses (As a percentage of projected average net assets) Management Fee (after waiver) (1)................. % % 12b-1 Fees (2).................................... 0.25% 0.25% Total Other Expenses (after waiver) (3)........... % % Total Class B Shares Operating Expenses (4)..... % %
(1) 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. (2) The Class B Shares can pay up to 0.75% of Class B Shares' average daily net assets as a 12b-1 fee. The Funds plan to limit the Class B Shares' 12b-1 payments to 0.25% of Class B Shares' average daily net assets. (3) Total Other Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the anticipated voluntary waivers by the administrator. The administrator may terminate these waivers at any time at its sole discretion. (4) Total Class B Shares Operating Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the voluntary waivers 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, 1994. 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 charges 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. The Funds charge no redemption fees for Class B Shares. Emerging Markets Growth Fund................................. $-- $-- International Equity Fund.................................... $-- $--
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, 1994. 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 Trust Shares, Class C Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. 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 5.00%. Class D 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%. Trust Shares, Class C Shares nor Class D Shares bear a front-end sales charge. See "Other Classes of Shares." - ------------------------ SUMMARY OF ------------------------ - ------------------------ FUND EXPENSES ------------------------ FIRST UNION INTERNATIONAL 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 offer- ing 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, and 0% after the sixth year and 0% after the sixth year Redemption Fee (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)............ % % 12b-1 Fees.............. 0.75% 0.75% Total Other Expenses (after waiver) (3)..... % % Shareholder Services Plan Fee............ 0.25% 0.25% Total Class C Shares Op- erating Expenses (4)................. % %
(1) No contingent deferred sales charge is imposed on (a) Shares purchased more than six 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 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 % and %, respectively, absent the anticipated voluntary waivers by the administrator. The administrator may terminate this waiver at any time at its sole discretion. (4) Total Class C Shares Operating Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the voluntary waivers 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, 1994. 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 charges 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....................................................... $-- $-- International Equity Fund.......................................................... $-- $-- You would pay the following expenses on the same investment, assuming no redemptions: Emerging Markets Growth Fund....................................................... $-- $-- International Equity Fund.......................................................... $-- $--
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 C Shares is based on estimated data for the fiscal year ending December 31, 1994. 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 Trust Shares, Class B Shares and Class D Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. Class B Shares are subject to a 12b- 1 fee of 0.25 of 1%and bear a maximum sales charge of 4.75%. Class D 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 INTERNATIONAL FUNDS CLASS D SHARES
Emerging Markets Growth International Fund Equity Fund -------- ------------- Class D Shares Shareholder Transaction Expenses Maximum Sales Load Imposed on Purchases (as a percentage of offering price)..................................... None None Maximum Sales Load Imposed on Reinvested Dividends (as a percentage of offering price).......................... None None Contingent Deferred Sales Charge (as a percentage of original purchase price or redemption proceeds, as applicable) (1)..................................... 1.00% 1.00% Redemption Fee (as a percentage of amount redeemed, if applicable)............................................ None None Exchange Fee............................................ None None Annual Class D Shares Operating Expenses (As a percentage of projected average net assets) Management Fee (after waiver) (2)....................... % % 12b-1 Fees.............................................. 0.75% 0.75% Total Other Expenses (after waiver) (3)................. % % Shareholder Services Plan Fee......................... 0.25% 0.25% Total Class D Shares Operating Expenses (4)......... % %
(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 % and %, respectively, absent the anticipated voluntary waivers by the administrator. The administrator may terminate these waivers at any time at its sole discretion. (4) Total Class D Shares Operating Expenses for Emerging Markets Growth and International Equity Funds are estimated to be % and %, respectively, absent the voluntary waivers 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, 1994. 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 charges 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................................. $-- $-- International Equity Fund.................................... $-- $--
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 D Shares is based on estimated data for the fiscal year ending December 31, 1994. The information set forth in the foregoing table and example relates only to Class D Shares of the Funds. The Funds also offer three additional classes of shares called Trust Shares, Class B Shares, and Class C Shares. In general, all expenses are allocated based upon the daily net assets of each class. Trust Shares bear no sales charge or 12b-1 fee. Class B Shares are subject to a 12b-1 fee of 0.25 of 1% and bear a maximum sales charge 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%, bear a maximum contingent deferred sales charge of 5.00%, and bear no front-end sales charge. See "Other Classes of Shares." - ------------------------- INVESTMENT ------------------------- - ------------------------- OBJECTIVES ------------------------- AND POLICIES First Union International 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. The Fund focuses on equity securities, but may also invest in other types of instruments, including debt securities. - ------------------------- 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 the Adviser and Boston International, the Sub- Adviser to the Fund, determine, 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 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. 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 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 Corporation ("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; 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; 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 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 or Sub-Advisers 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 portfolio securities on a when-issued or delayed delivery basis. In such cases, a Fund commits to purchase a security which will be delivered and paid for at a future date. The Fund relies on the seller to deliver the securities and risks missing an advantageous price or yield if the seller does not deliver the security as promised. 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 Fund's 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 Adviser or each Sub-Adviser will consider the likelihood of changes in currency values when making investment decisions, the Adviser or 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 Fund's assets denominated in that currency. OPTIONS AND FUTURES The Funds may deal in options on foreign currencies, and securities indices, 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 Adviser or 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 a 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 the Adviser or 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 in the Statement of Additional Information, 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 securities. 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. 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. 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 B Shares, Class C Shares or Class D 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 B Shares, Class C Shares and Class D 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 B Shares, Class C Shares, and Class D Shares is based on purchasing arrangements and distribution and shareholder services expenses. Class B 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 B Shares for the same initial investment than Class C Shares or Class D Shares due to the initial sales charge, but will receive higher dividends per Share due to the lower distribution expenses. Class C Shares impose a maximum contingent deferred sales charge ("CDSC") of 5.00% on most redemptions made within six years of purchase, have distribution costs resulting from Rule 12b-1 distribution fees of 0.75% and a shareholder services fee of 0.25%. In addition, at the end of the seven year period, Class C Shares may automatically convert to Class B Shares and thus be subject to lower Rule 12b-1 distribution fees. Class D 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 C Shares or Class D Shares than Class B 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 C Shares or Class D Shares would be less than the initial sales charge and accumulated Rule 12b-1 fee on Class B Shares purchased at the same time. Investors must also consider how each differential would be offset by the higher yield of Class B 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 B Shares adds an applicable sales charge, and the redemption proceeds of Class C Shares and Class D 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 Trust Shares of a Fund may differ slightly from that of Class B Shares, Class C Shares, and Class D 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 C Shares and Class D 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 B Shares, Class C Shares, and Class D 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 B Shares, Class C Shares and Class D 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 B Shares, Class C Shares and Class D Shares of the Funds and, therefore, may not correlate to the dividends or other distributions paid to shareholders. Performance information for the Class B Shares, Class C Shares and Class D 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 B Shares, Class C Shares, Class D Shares and Trust Shares of a Fund. Because Class B Shares are subject to 12b-1 fees, and Class C Shares and Class D Shares are subject to a 12b-1 fee and a shareholder services fee, the yield will be lower than that of Trust Shares. The sales load applicable to Class B Shares also contributes to a lower total return for Class B Shares. In addition, Class C Shares and Class D Shares are subject to similar non-recurring charges, such as the CDSC, which, if excluded, would increase the total return for Class C Shares and Class D 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 B Shares), or (ii) on a contingent deferred basis (in the case of Class C Shares and Class D 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 B 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% 4.25% $ 100,000-$ 249,999 3.75% 3.25% $ 250,000-$ 499,999 3.00% 2.50% $ 500,000-$ 999,999 2.00% 1.75% $1,000,000-$2,499,999 1.00% 1.00% $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 family, 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 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 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 six 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 None
Class D 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 C Shares and Class D 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 six years (in the case of Class C Shares) or one year (in the case of Class D 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 C 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 C Shares was accepted. At the end of this seven year period, Class C Shares may automatically convert to Class B Shares, in which case the Shares will no longer be subject to the higher Rule 12b-1 distribution fee which is assessed on Class C 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 C 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 C Shares from most of the burden of such distribution-related expenses. For purposes of conversion to Class B Shares, Class C Shares purchased through the reinvestment of dividends and distributions paid on Class C Shares in a shareholder's Fund acount will be considered to be held in a separate sub- account. Each time any Class C Shares in the shareholder's Fund account (other than those in the sub-account) convert to Class B Shares, an equal pro rata portion of the Class C Shares in the sub-account will also convert to Class B 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 B Shares, Class C Shares and Class D 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 B Shares of one First Union Fund for Class B Shares of any other First Union Fund, Class C Shares of one First Union Fund for Class C Shares of any other First Union Fund, or Class D Shares of one First Union Fund for Class D 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, upon receipt of the proceeds by the First Union Fund, shares of the other First Union Fund will be purchased at their offering price determined after the proceeds from such redemption become available, which may be up to seven days after such redemption. 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 C Shares or Class D Shares will not be subject to a CDSC. However, if the shareholder redeems Class C Shares within six years of the original purchase or Class D 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 C Shares or Class D 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 C Shares or Class D 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 State Street Bank, 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 the 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 WITHDRAWAL PLAN If you are a shareholder with an account valued at $10,000 or more, you may have amounts of $100 or more sent from your account to you on a regular monthly or quarterly basis. 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 $ billion in total consolidated assets as of June 30, 1994. Through offices in 36 states and one foreign country, 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 $ billion. In addition, the Capital Management Group has advised the Trust since its inception in 1984. As part of their 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 these 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 holders. 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 $ billion in investments for 32 institutional investors. As of June 30, 1994, Marvin & Palmer served as investment adviser or sub- adviser to one other investment company with total assets of $32.6 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 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 and Portfolio Manager of the Sub-Adviser. Before joining the Sub-Adviser in 1990, Mr. Mason was employed for 14 years by DuPont Corporation, the last five as International Equity Analyst and 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 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 twenty international portfolios, including five group trust funds, for pensions and endowment plans 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 $ billion in assets under management. In addition, as of June 30, 1994, Boston International served as investment adviser or sub-adviser to one other investment company with total assets of $146.4 million. Maureen Ghublikian has been a Managing Director of the Sub-Adviser since the firm's inception in 1986. In 1986, she was promoted to Vice President. Ms. Ghublikian has managed the Fund since its inception in September 1994. David A. Umstead has been a founder and Managing Director of the Sub-Adviser since the firm's inception in 1986. Mr. Umstead has managed the Fund since its inception in September 1994. 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 the average daily net asset value of the Fund 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% for Class B Shares of the Funds and 0.75% for Class C Shares and Class D Shares of a 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 its distributor. The distributor, however, may pay a sales commission to brokers (including FUBS) in connection with the sale of Class C Shares and Class D 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 C Shares and Class D Shares. First Union Corporation currently serves as principal lender in this financing program. Actual distribution expenses for Class C Shares and Class D 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"), 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 ("State Street Bank"), Boston, Massachusetts, serves as custodian for the securities and cash of the Funds. Federated Services Company, a subsidiary of Federated Investors, serves as transfer agent and provides dividend disbursement and other shareholder services for the Funds. First Union Brokerage Services, Charlotte, North Carolina, is the shareholder servicing agent for Class C Shares and Class D Shares of the Funds. As such, FUBS 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 shares. The Funds may pay FUBS a fee equal to 0.25 of 1% of the average daily net asset value of Class C Shares and Class D Shares for which FUBS provides shareholder services. FUBS may voluntarily choose to waive all or a portion of its fee at any time. 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., and legal counsel to the Trust is provided by Houston, Houston & Donnelly, Pittsburgh, Pennsylvania. The independent auditors for the Trust are KPMG Peat Marwick, 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 objectives and policies. For its services under the Sub-Advisory Contract, 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 B Shares, Class C Shares and Class D Shares. In addition, the Funds' expenses under the Shareholder Services Plan are incurred by the Class C Shares and Class D 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 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. - ------------------------ 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 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 International Funds offer four classes of shares: Class B Shares, Class C Shares and Class D Shares for individuals and other customers of First Union and Trust Shares for institutional investors. Trust 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. Trust 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 B Shares, Class C Shares and Class D Shares will be less than those payable to Trust Shares by the difference between class expenses and distribution and shareholder services expenses borne by the shares of each respective class. - ------------------------- 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 Fund Marvin & Palmer Associates, Inc. One Commerce Center Suite 1100 Wilmington, Delaware 19801 - -------------------------------------------------------------------------------- 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 - -------------------------------------------------------------------------------- Legal Counsel to the Trust Houston, Houston & Donnelly 2510 Centre City Tower Pittsburgh, Pennsylvania 15222 - -------------------------------------------------------------------------------- Independent Auditors KPMG Peat Marwick One Mellon Bank Center Pittsburgh, Pennsylvania 15219 - -------------------------------------------------------------------------------- FIRST UNION EMERGING MARKETS GROWTH PORTFOLIO FIRST UNION INTERNATIONAL EQUITY PORTFOLIO PORTFOLIOS OF FIRST UNION FUNDS TRUST SHARES CLASS B INVESTMENT SHARES CLASS C INVESTMENT SHARES CLASS D INVESTMENT SHARES COMBINED STATEMENT OF ADDITIONAL INFORMATION This Combined Statement of Additional Information should be read with the respective prospectus of Trust Shares, Class B Investment Shares, Class C Investment Shares, or Class D Investment Shares for First Union International Funds, dated September , 1994. This Statement is not a prospectus itself. To receive a copy of the Trust 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 B Investment Shares', Class C Investment Shares', and Class D 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 September , 1994 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 Emerging Markets 4 Restricted Securities 4 When-Issued and Delayed Delivery Transactions 5 Lending of Portfolio Securities 5 Repurchase Agreements 5 Reverse Repurchase Agreements 5 Portfolio Turnover 5 Investment Limitations 6 TRUST MANAGEMENT 8 - ----------------------------------------------------------------- Officers and Trustees 8 Fund Ownership 9 Trustee Liability 9 INVESTMENT ADVISORY SERVICES 9 - ----------------------------------------------------------------- Adviser to the Funds 9 Sub-Advisers 9 Advisory Fees 9 Sub-Advisory Fees 9 BROKERAGE TRANSACTIONS 10 - ----------------------------------------------------------------- ADMINISTRATIVE SERVICES 10 - ----------------------------------------------------------------- PURCHASING SHARES 10 - ----------------------------------------------------------------- Distribution Plans (Class B, Class C and Class D Investment Shares) 11 DETERMINING NET ASSET VALUE 12 - ----------------------------------------------------------------- Determining Market Value of Securities 12 Trading in Foreign Securities 12 REDEEMING SHARES 12 - ----------------------------------------------------------------- Redemption in Kind 13 TAX STATUS 13 - --------------------------------------------------------------- The Fund's Tax Status 13 Foreign Taxes 13 Shareholders' Tax Status 13 TOTAL RETURN 13 - ----------------------------------------------------------------- YIELD 13 - ----------------------------------------------------------------- PERFORMANCE COMPARISONS 14 - ----------------------------------------------------------------- APPENDIX 15 - ----------------------------------------------------------------- I 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: Trust Shares, Class B Investment Shares, Class C Investment Shares, and Class D 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 First Union National Bank, the Funds' investment adviser, or Marvin & Palmer Associates, Inc., the sub-adviser to the Emerging Markets Growth Fund or Boston International Advisors, Inc., the sub-adviser to the International Equity Fund ("Sub-Adviser") (collectively referred to as "Adviser"), the investment characteristics of the underlying common shares will assist a Fund in achieving its investment objective. A Fund may also elect to hold or trade convertible securities. In selecting convertible securities, the Adviser evaluates 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 Adviser considers 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. SECURITIES OF SMALL 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. 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 Adviser believes that it is important to have the flexibility to enter into forward foreign currency exchange contracts whenever it determines 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 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 Adviser, 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 Adviser, 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. 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. 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 The Funds engage in when-issued and delayed delivery transactions only for the purpose of acquiring portfolio securities consistent with a Fund's investment objective and policies, not for investment leverage. These transactions are made to secure what is considered to be an advantageous price or yield for the Funds. 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. No fees or other expenses, other than normal transaction costs, are incurred. However, liquid assets of a Fund sufficient to make payment for the securities to be purchased are segregated at the trade date. These securities are marked to market daily and maintained until the transaction is settled. Each Fund may engage in these transactions to an extent that would cause the segregation of an amount up to 20% of the total value of its 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 % and %, respectively. 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 a sub-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. 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 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." TRUST MANAGEMENT - -------------------------------------------------------------------------------- OFFICERS AND TRUSTEES Officers and Trustees of the Trust are listed with their address, principal occupations, and present positions, including any affiliation with First Union National Bank of North Carolina ("First Union"), Boston International Advisors, Inc. ("Boston International"), Marvin & Palmer Associates, Inc. ("Marvin & Palmer"),Federated Investors, Federated Securities Corp., Federated Services Company, or Federated Administrative Services.
POSITIONS WITH PRINCIPAL OCCUPATIONS NAME THE TRUST DURING PAST FIVE YEARS - ----------------------------------------------------------------------------------------------------------------------------------- James S. Howell Chairman of Retired Vice President of Lance Inc. (food manufacturing). the Board and Trustee - ----------------------------------------------------------------------------------------------------------------------------------- Gerald M. McDonnell Trustee Sales Representative with Nucor-Yamoto, Inc. (steel producer) (since 1988); formerly with Northwestern Steel & Wire Company (1986-1988). - ----------------------------------------------------------------------------------------------------------------------------------- Thomas L. McVerry 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* 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. 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 Trustee Attorney; formerly, Partner with Wardlow, Knox, Knox, Freeman & Scofield (attorneys) (1982-1986). - ----------------------------------------------------------------------------------------------------------------------------------- Edward C. Gonzales* President, Vice President, Treasurer, and Trustee, Federated Investors; Vice Treasurer, and President and Treasurer, Federated Advisers, Federated Management, and Trustee Federated Research; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company; 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 Vice President and Vice President, Federated Administrative Services; Director, Private Assistant Treasurer 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 Secretary Corporate Counsel, Federated Investors. - -----------------------------------------------------------------------------------------------------------------------------------
*This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940. The address of the officers and Trustees of the Trust is Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779. FUND OWNERSHIP Officers and Trustees own less than 1% of the Fund's outstanding Shares. 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 (the "Adviser") is First Union National Bank of North Carolina. 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, Fund 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 their advisory services, the Adviser receives an annual investment advisory fee as described in the respective prospectus. SUB-ADVISORY FEES For their sub-advisory services, Marvin & Palmer and Boston International receive an annual sub-advisory fee as described in the respective prospectus. STATE EXPENSE LIMITATIONS The Adviser and Sub-Advisers have undertaken to comply with the expense limitations established by certain states for investment companies whose shares are registered for sale in those states. If a 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 and Sub-Adviser will reimburse the Funds for its expenses over the limitation. 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 and Sub-Adviser will be limited, in any single fiscal year, by the amount of their advisory fees. This arrangement is not part of the advisory contract or sub-advisory agreement 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 and Sub-Adviser look for prompt execution of the order at a favorable price. In working with dealers, the Adviser and Sub-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 and Sub-Adviser may, from time to time, use brokers affiliated with the Trust, Federated Securities Corp., or their affiliates. The Adviser and Sub-Adviser make decisions on portfolio transactions and select brokers and dealers subject to review by the Trustees. The Adviser and Sub-Adviser may select brokers and dealers who offer brokerage and research services. These services may be furnished directly to the Funds or to the Adviser and Sub-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 Sub-Adviser 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 Adviser and Sub-Adviser in advising the Funds and other accounts. To the extent that receipt of these services may supplant services for which the Adviser and Sub-Adviser or its 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 Adviser and 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 Adviser and/or 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 Adviser and 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. 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. 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 B 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 B, CLASS C, AND CLASS D INVESTMENT SHARES) With respect to the Class B, Class C, and Class D 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 B, Class C, and Class D Investment Shares. The Plans are designed to (i) stimulate brokers to provide distribution and administrative support services to the Funds and holders of Class B, Class C, and Class D Investment Shares and (ii) stimulate administrators to render administrative support services to the Funds and holders of Class B, Class C, and Class D 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 B, Class C, and Class D 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 B, Class C, and Class D 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. 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 financial institutions may be required to register as dealers pursuant to state law. Although state securities laws differ, administrators in some states may be required to register as brokers and dealers pursuant to state law. 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. 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 maturities of less than 60 days 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 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 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' 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 FUND'S TAX STATUS The Funds 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 Funds 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. 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 average annual total return for all classes of Shares of a 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. YIELD - -------------------------------------------------------------------------------- The yield for all classes of Shares of a 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 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 a 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, 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 monthly 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. APPENDIX - -------------------------------------------------------------------------------- STANDARD & POOR'S CORPORATION LONG-TERM BOND RATING DEFINITIONS AAA--Debt rated AAA has the highest rating assigned by Standard & Poor's Corporation. 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 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 CORPORATION 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. 3092403B (6/94) -----END PRIVACY-ENHANCED MESSAGE-----