-----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, pB4EQ4qVQlqmnEcpupS8KusyJgkMe+e5oEz9gW8KaKl4QKByPPhEx+ugBlPxXUOX 7QzKIbRy5PyFRziI5d7ppA== 0000950007-95-000121.txt : 19950814 0000950007-95-000121.hdr.sgml : 19950814 ACCESSION NUMBER: 0000950007-95-000121 CONFORMED SUBMISSION TYPE: 497 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19950811 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: BLANCHARD FUNDS CENTRAL INDEX KEY: 0000789289 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 133333918 STATE OF INCORPORATION: MA FISCAL YEAR END: 0430 FILING VALUES: FORM TYPE: 497 SEC ACT: 1933 Act SEC FILE NUMBER: 033-03165 FILM NUMBER: 95561842 BUSINESS ADDRESS: STREET 1: 41 MADSON AVE 24TH FL CITY: NEW YORK STATE: NY ZIP: 10010 BUSINESS PHONE: 2127797979 MAIL ADDRESS: STREET 1: 41 MADISON AVENUE 24TH FLOOR CITY: NEW YORK STATE: NY ZIP: 10010 FORMER COMPANY: FORMER CONFORMED NAME: BLANCHARD STRATEGIC GROWTH FUND DATE OF NAME CHANGE: 19901225 497 1 FORM N-1A - -------------------------------------------------------------------------------- LOGO THE BLANCHARD GROUP OF FUNDS Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779 Blanchard Funds (the "Trust"), which currently consists of ten investment portfolios, and Blanchard Precious Metals Fund, Inc. (the "Company"), which currently consists of one investment portfolio (each portfolio individually referred to as a "Fund" and collectively as the "Funds") are open-end management investment companies, which offer separate investment alternatives for different investor needs. Virtus Capital Management, Inc. is the Funds' overall manager. There is no guarantee that the Funds will achieve their investment objectives. There can be no assurance that Blanchard 100% Treasury Money Market Fund will maintain a stable $1.00 share price. Highlights ................................................................. 3 Fee Table .................................................................. 5 Financial Highlights ...................................................... 6 The Funds' Investment Objectives and Policies ............................. 10 Management of the Funds ................................................... 26 Portfolio Advisory Services ............................................... 28 How to Invest ............................................................. 32 Investor Services ......................................................... 34 How to Redeem ............................................................. 36 Distribution of Shares of the Funds ....................................... 37 Tax Matters ............................................................... 39 Performance Information ................................................... 41 Additional Information About the Funds .................................... 42 Additional Investment Information ......................................... 44 Certain Investment Strategies and Policies ................................ 48 Risk Factors and Special Considerations ................................... 55 Appendix A-Description of Bond Ratings .................................... A-1 --------------- Please read this Prospectus carefully and retain it for future reference. A copy of each Fund's Statement of Additional Information, dated August 7 1995, has been filed with the Securities and Exchange Commission (the "SEC") and is incorporated herein by reference. The Statements of Additional Information are available upon request to the Funds at 1-800-829-3863. Investment products offered through Signet Financial Services, Inc. are not deposits, obligations of, or guaranteed by Signet Bank, and are not insured by FDIC or any Federal agency. In addition, they involve risk, including possible loss of principal invested. Member NASD. --------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURI- TIES 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 REPRESENTA- TION TO THE CONTRARY IS A CRIMINAL OFFENSE. Prospectus dated August 7, 1995 - -------------------------------------------------------------------------------- The Funds' investment objectives and policies are summarized below. See "The Funds' Investment Objectives and Policies" for a more complete discussion. Blanchard Global Growth Fund ("BGGF") seeks to provide long-term capital growth. As worldwide investment and economic trends change rapidly, the flexible investment strategy of the Fund permits it to follow a global allocation strategy that contemplates shifts among strategic market sectors. These include the following: U.S. Equities; Foreign Fixed Income; Foreign Equities; Precious Metals Securities and Bullion; U.S. Fixed Income; and Emerging Markets. Blanchard American Equity Fund ("BAEF") seeks to provide long-term growth of capital. The Fund invests primarily in equity securities, consisting of common stocks and securities having the characteristics of common stocks, such as convertible preferred stocks, convertible debt securities and warrants. In pursuing its investment objective of long-term growth of capital, the Fund will invest at least 65% and under normal circumstances expects to invest at least 80% of its assets in equity securities of companies of various sizes which are currently experiencing a rate of earnings growth greater than the average of such rate for all companies included in Standard & Poor's 500-Stock Index. Blanchard Precious Metals Fund, Inc. ("BPMF") seeks to provide long-term capital appreciation and preservation of purchasing power through investments in physical precious metals, such as gold, silver, platinum and palladium, and in securities of companies involved with precious metals. A secondary objective of the Fund is to reduce the risk of loss of capital and decrease the volatility often associated with precious metals investments by changing the allocation of its assets from precious metals securities to physical precious metals and/or investing in short-term instruments and government securities during periods when the Fund's portfolio manager believes the precious metals markets may experience declines. Blanchard Short-Term Global Income Fund ("BSTGIF") seeks to produce high current income with minimum risk of principal and relative stability of net asset value. The Fund seeks to achieve its objective by investing primarily in a portfolio of debt obligations rated in the four highest rating categories of nationally recognized rating services, denominated in the U.S. dollar and various foreign currencies, which have average remaining maturities not exceeding three years. Accordingly, it will seek investment opportunities in foreign, as well as domestic, securities markets. The Fund is designed for investors who seek higher yield than a money market fund and less fluctuation in net asset value than a longer-term bond fund. Blanchard Short-Term Bond Fund ("BSTBF") seeks to provide a high level of current income consistent with preservation of capital by investing primarily in a broad range of short-term debt securities. The Fund will normally maintain a dollar-weighted average portfolio maturity of three years or less. The Fund intends to invest primarily in investment-grade securities. Blanchard Flexible Tax-Free Bond Fund ("BFTFBF") seeks to provide a high level of current interest income exempt from Federal income tax consistent with the preservation of principal. The Fund invests primarily in bonds of varying maturities issued by or on behalf of states, territories and possessions of the United States and the District of Columbia and their political subdivisions, agencies, authorities and instrumentalities, the interest from which, in the opinion of bond counsel for the issuer, is exempt from Federal income tax. The Fund has no restrictions on the maturities of bonds that it may purchase. Rather, it retains the flexibility to lengthen or shorten the overall maturity of its portfolio based on its portfolio adviser's outlook on interest rate movements, as it attempts to reduce any price volatility. The Fund invests primarily in high quality, investment-grade bonds. 2 Blanchard 100% Treasury Money Market Fund ("BTMMF") seeks to offer the highest level of current income as is consistent with the preservation of capital and maintenance of liquidity, by investing exclusively in short-term, direct obligations of the U.S. Treasury. The Fund will not invest in repurchase agreements, certificates of deposit of commercial banks or savings and loan institutions, nor will it invest in obligations issued or guaranteed by U.S. Government agencies or instrumentalities, or in corporate debt securities. Portfolio securities of the Fund are considered by many to be among the safest investments available. However, shares of this Fund are neither insured nor guaranteed by the U.S. Government. There is no assurance that the Fund will be able to maintain a stable net asset value of $1.00 per share. Blanchard Flexible Income Fund ("BFIF") seeks to provide high current income while seeking opportunities for capital appreciation. The Fund is designed for fixed-income investors with a long-term investment horizon. The Fund invests in different fixed income securities markets: U.S. Government Securities, Investment Grade Fixed Income Securities, High Yield Securities and International Fixed Income Securities. In seeking its objective of high current income, the Fund also takes into consideration preservation of capital. Blanchard Worldwide Emerging Markets Fund ("BWEMF") seeks to provide capital appreciation and current income by investing primarily in equity and fixed income securities in emerging markets around the world. The Fund is designed for investors who seek an easy way to capitalize on opportunities in developing countries. While investments in emerging markets offer potential for substantial gains, they also entail risks that may not be present in developed markets. These markets are growing rapidly, but many are still young and relatively small. Therefore, investors can expect to see volatility and reduced liquidity at times, which is why investments in emerging markets are best suited for investors with a longer investment horizon. HIGHLIGHTS Fund Management Virtus Capital Management, Inc. ("VCM") provides the overall management services necessary for the Funds' operations. As of April 30, 1995, VCM had more than $3 billion in assets under management. VCM selected, continually monitors and evaluates the Funds' Portfolio Advisers. The Portfolio Advisers are responsible for the selection of each Fund's portfolio investments (except BTMMF which is managed directly by VCM). VCM receives monthly compensation from each Fund based on the amount of assets under management. VCM, not the Fund, pays the fees of each Portfolio Adviser pursuant to a sub-advisory agreement. See "Management of the Funds" and "Portfolio Advisory Services". How to Invest and Redeem You may purchase shares directly from Federated Securities Corp. (the "Distributor"), which is each Fund's principal distributor. You may also purchase shares from broker-dealers who have entered into a dealer agreement with the Distributor. The minimum amount required to open an account in any of the Funds (other than BTMMF) is $3,000 ($2,000 for qualified retirement plans, such as IRAs and Keoghs). The minimum initial investment requirement for BTMMF is only $1,000. The minimum subsequent investment requirement for all Funds is $200. There is no fee for additional investments made to existing accounts, nor is there a fee charged when redeeming shares, sometimes called a back-end load. Each Fund (other than BTMMF) has also adopted a Distribution and Marketing Plan which permits the reimbursement of distribution expenses by the Fund on an annual basis. See "How to Invest" and "Distribution of Shares of the Funds". 3 You may redeem your shares on any business day at the next determined net asset value calculated after the Transfer Agent has received the redemption request in proper form. See "How to Redeem". Each Fund reserves the right to close to further new investments if such Fund's Portfolio Adviser believes that the Fund's size may hamper their effectiveness in managing the portfolio. In this event, no new investments will be accepted until further review. Shareholders who have established accounts prior to the closure date will be allowed to add to their accounts. Investor Services and Privileges The Funds offer certain investor services and privileges that may be suited to your particular investment needs, including free Telephone Exchange Privileges, Investment and Withdrawal Plans and various Retirement Plans. See "Investor Services". Dividends The growth funds intend to declare dividends at least annually from net investment income. The income funds intend to declare dividends monthly or quarterly from net investment income. Dividends are automatically reinvested in additional Fund shares at net asset value on the payment date and are reflected in the statements we send you, unless you elect to receive them in cash, in which case we will send you a quarterly check. See "Tax Matters". Special Considerations BTMMF is a diversified fund, and the other Funds are non-diversified funds. Non-diversified Funds may be invested in a limited number of issues; thus, there may be greater risk in an investment in these Funds other than in diversified investment companies. Moreover, there are potential risks associated with certain of the Funds' investments and additional risk considerations that may be associated with certain techniques and strategies employed by the Funds, including those relating to investments in foreign securities and futures and options transactions. Such risks may not be incurred by other investment companies which have similar investment objectives, but which do not use these techniques and strategies. Blanchard Funds is organized as a Massachusetts business trust and the Blanchard Precious Metals Funds, Inc. is organized as a Maryland corporation. In each state, nomenclature varies. For convenience, in this Prospectus, you will be referred to as "shareholders," your Fund shares as "shares" and your directors or trustees as "Board Members." In addition, the portfolio advisers, sector managers and the allocation strategist will be collectively referred to as "Portfolio Advisers". 4 FEE TABLE For a better understanding of the expenses you will incur when investing in the Funds, a summary of expenses based on the year ended April 30, 1995 is set forth below. There is no sales commission on any purchase of Fund shares.
Shareholder Transaction Expenses BGGF BTMMF BSTGIF BFIF BSTBF BWEMF BAEF BFTFBF BPMF ---- ----- ------ ---- ----- ------ ---- ------ ---- Sales Commission on Purchase of Shares .................. NONE NONE NONE NONE NONE NONE NONE NONE NONE Sales Commission on Reinvestment of Dividends ........... NONE NONE NONE NONE NONE NONE NONE NONE NONE Sales Commission on Redemption of Shares ................ NONE NONE NONE NONE NONE NONE NONE NONE NONE Annual Fund Operating Expenses (as a % of average net assets) Management Fees (After Fee Waiver) (See "Management of the Funds") .......... 1.00% .42% .71% .74%1 .17%1 .59% .31% .11% 1.00% 12b-1 Fees ............................ .75%4 NONE .24%2 .25%2 .23%2 .50%3 .50%3 0% .75%4 Other Expenses (See "Management of the Funds")5 .... .76% .57% .56% .59% .98% 2.50% 2.24% .89% .74% Total Fund Operating Expenses6 ........ 2.51% .99% 1.51% 1.58% 1.38% 3.59% 3.05% 1.00% 2.49% Example: You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each time period 1 year .............................. $ 26 $ 10 $ 15 $ 16 $ 14 $ 37 $ 31 $ 10 $ 26 3 years ............................. 79 32 48 50 44 112 96 32 78 5 years ............................. 135 55 83 87 76 189 162 55 134 10 years ............................ 287 122 181 189 167 391 340 123 285
This example should not be considered a representation of past or future expenses, and actual expenses may be greater or less than those shown. In addition, the 5% annual return should not be considered representative of past or future returns, and actual returns may be greater or less than the illustration above. - ---------------------- 1. VCM has conditioned its right to receive a portion of any earned but deferred fees and expenses based upon these Funds reaching and maintaining a certain level of net assets. See "Management of the Funds." 2. As a result of distribution fees of .25% per annum of the Fund's average daily net assets, a shareholder who has been in the Fund for 29 years may pay more than the economic equivalent of the maximum front-end sales charges permitted by the Rules of the National Association of Securities Dealers, Inc. 3. As a result of distribution fees of .50% per annum of the Fund's average daily net assets, a shareholder who has been in the Fund for 14.5 years may pay more than the economic equivalent of the maximum front-end sales charges permitted by the Rules of the National Association of Securities Dealers, Inc. 4. As a result of distribution fees of .75% per annum of the Fund's average daily net assets, a shareholder who has been in the Fund for 9.6 years may pay more than the economic equivalent of the maximum front-end sales charges permitted by the Rules of the National Association of Securities Dealers, Inc. 5. Other Expenses include, among other costs, custodian, transfer agent, administration, legal and auditing fees. 6. VCM has agreed to cap the Fund's total operating expenses until July 11, 1997, so that the expense ratio of each Fund will not exceed the Fund expense ratio for the fiscal year ended April 30, 1995. 5 FINANCIAL HIGHLIGHTS (For a Share Outstanding throughout each Period) The following selected per share data and ratios, insofar as they relate to each of the years in the period ended April 30, 1995, have been audited by Price Waterhouse LLP, independent accountants. The related financial statements and unqualified report of independent accountants thereon for the five years ended April 30, 1995 are included in each Fund's Statement of Additional Information. This information should be read in conjunction with the financial statements and notes thereto. Further information about the Funds' performance is contained in each Funds' annual report, which may be obtained without charge by writing to the address or calling the number set forth on the cover page of this Prospectus. BLANCHARD GLOBAL GROWTH FUND
Dividends to Total Share- Distribu- Realized from holders tions to Distri- and Invest- from Share- butions Net Net Asset Net Net Net Asset Invest- Unrealized ment Invest- holders in excess Asset Total at End of Expenses Investment Year Value at ment Gain (Loss) Income ment from of net Value at Invest- Year to Income to Port- Ended Beginning Income on invest Opera- Income Realized Realized End ment (000 Average Average folio April 30 of Period --Net ments--Net tions --Net Gains--Net Gains of Period Return omitted) Net Assets Net Assets Turnover - -------- --------- ------- ----------- ------ ------- ---------- ------- --------- ------ --------- ---------- ---------- -------- 1995 ..... $10.04 $ .08 $(.19) $(.11) $ - $ - $ (.22) $ 9.71 (1.04%) $ 87,000 2.51% .76% 221.0% 1994 ..... 10.00 .03 1.29 1.32 0 (1.28) - 10.04 12.91% 109,805 2.61% .67% 166.0% 1993 ..... 9.92 .25 .32 .57 (.30) (.19) - 10.00 6.08% 84,780 2.40% 1.72% 138.0% 1992 ..... 9.64 .33 .26 .59 - 0 - 9.92 6.24% 128,047 2.31% 2.31% 108.6% 1991 ..... 9.62 .30 .135 .435 (.2075) (.2075) - 9.64 4.61% 193,593 2.36% 2.84% 78.3% 1990 ..... 10.11 .30 .09 .39 (.375) (.505) - 9.62 3.74% 233,300 2.28% 2.86% 88.4% 1989 ..... 9.68 .22 .49 .71 (.10) (.18) - 10.11 7.54% 244,048 2.29% 2.27% 85.2% 1988 ..... 10.51 .14 (.21) (.07) (.12) (.64) - 9.68 (.57%) 246,569 2.28% 1.42% 119.8% 1987(a) .. 8.00 .01 2.50 2.51 - - - 10.51 31.38%d 149,018 3.10%(b)(c) .34%(b)(c) 69.7% - ---------- (a) Represents period from June 1, 1986 (commencement of the Fund's operations) to April 30, 1987. (b) Net of expense reimbursement. (c) Annualized. (d) Not annualized.
BLANCHARD 100% TREASURY MONEY MARKET FUND
Realized Dividends Distri- and to butions Unrealized Share- to Gain Total holders Share- Net Net Ratio of (Loss) from from holders Total Asset Asset Ratio of Net Net Asset Invest- on Invest- Invest- from Dividends Value Total at End Net Investment Year Value at ment Invest- ment ment Realized and at Invest- of Year Expenses Income to Ended Beginning Income ments Income Income Gains Distri- End of ment (000 to Average Average Net April 30 of Period --Net --Net Operations --Net --Net butions Period Return omitted) Net Assets Assets - -------- --------- ------ ------- ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- 1995 .... $1.00 $.04 - $.04 $(.04) - $(.04) $1.00 4.02% $165,000 .99%(c)(d) 3.83%(c)(d) 1994 .... 1.00 .03 - .03 (.03) - (.03) 1.00 2.76% 230,790 .41%(c)(d) 2.80%(c)(d) 1993 .... 1.00 .03 - .03 (.03) - (.03) 1.00 3.42% 164,974 .08%(c)(d) 3.27%(c)(d) 1992 .... 1.00 .04 - .04 (.04) - (.04) 1.00 4.60% 57,847 .86%(c)(d) 4.52%(c)(d) 1991 .... 1.00 .07 - .07 (.07) - (.07) 1.00 6.80% 38,472 1.11%(c)(d) 6.62%(c)(d) 1990 .... 1.00 .08 - .08 (.08) - (.08) 1.00 8.11% 44,906 1.04%(d) 7.63%(c)(d) 1989(b) . 1.00 .02 - .02 (.02) - (.02) 1.00 1.67%(e) 24,833 .42%(a)(c)(d)9.12%(a)(d) - ----------- (a) Annualized. (b) Represents period from February 24, 1989 (commencement of the Fund's operations) to April 30, 1989. (c) Net of expenses borne by Sheffield Management Company (the "prior manager"). (d) The net expense ratio to average net assets and investment income ratio to average net assets would have been 1.07% and 3.75%, respectively, for the year ended April 30, 1995, .93% and 2.29% respectively for the year ended April 30, 1994, .92% and 2.43% respectively, for the year ended April 30, 1993, 1.46% and 3.92%, respectively, for the year ended April 30, 1992, 1.23% and 6.50%, respectively, for the year ended April 30, 1991, 1.16% and 7.51%, respectively, for the year ended April 30, 1990, and 3.50% and 6.05%, respectively, for the period ended April 30, 1989, if the management fee had not been waived and other expenses had not been borne by the prior manager. (e) Not annualized.
6 BLANCHARD SHORT-TERM GLOBAL INCOME FUND
Realized Dividends and to Unrealized Share- Gain Total holders Net Net Ratio of (Loss) from from Asset Asset Ratio of Net Net Asset Invest- on Invest- Invest- Tax Change Value Total at end Net Investment Year Value at ment Invest- ment ment Return in net at Invest- of Year Expenses Income to Ended Beginning Income ments Income Income of Asset End of ment (000 to Average Average Net Portfolio April 30 of Period --Net --Net Operations --Net Capital Value Period Return omitted) Net Assets Assets Turnover - -------- --------- ------ ------- ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- --------- 1995 .... $1.79 $.10(D)$(.07)(D)$(.03) $ - $(.10) $(.13) $1.66 (1.45%) $ 234,000 1.51%(2) 5.95%(2) 386% 1994 .... 1.85 .12 (.06) .06 (.01) (.11) (.06) 1.79 3.12% 535,141 1.44% 6.41% 327% 1993 .... 1.89 .13 (.04) .09 (.13) - (.04) 1.85 4.94% 699,182 1.44%** 6.97%** 610% 1992 .... 1.95 .17** (.06) .11 (.17) - (.06) 1.89 5.85% 1,240,563 1.32%**(2) 8.50%**(2) 412% 1991* 1.97 .06** (.02) .04 (.06) - (.02) 1.95 2.15%(3) 230,233 .38%**(1)(2) 11.30%**(1)(2) 63% - ---------- * Represents period from January 8, 1991 (commencement of the Fund's operations) to April 30, 1991. ** Net of fees waived by the prior manager and Sheffield Investments, Inc. (the "prior distributor") and expenses borne by the prior manager. (1) Annualized. (2) The net expense ratio to average net assets and investment income ratio to average net assets would have been 1.56% and 5.90%, respectively, for the year ended April 30, 1995, 1.41% and 8.41%, respectively, for the year ended April 30, 1992 and 2.23% and 9.45%, respectively, for the period ended April 30,1991 if the management and distribution fees had not been waived and other expenses had not been borne by the prior manager. (3) Not annualized. (D) Calculated based on average shares outstanding.
BLANCHARD FLEXIBLE INCOME FUND
Realized Dividends Distri- and to butions Unrealized Share- to Gain Total holders Share- Net Net Ratio of (Loss) from from holders Asset Asset Ratio of Net Net Asset Invest- on Invest- Invest- from Tax Value Total at end Net Investment Year Value at ment Invest- ment ment Realized Return at Invest- of Year Expenses Income to Ended Beginning Income ments Income Income Gains of End of ment (000 to Average Average Net Portfolio April 30 of Period --Net --Net Operations --Net --Net Capital Period Return omitted) Net Assets Assets Turnover - -------- --------- ------ ------- ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- --------- 1995 .... $4.85 $ .30(4) $(.13) $ .47 $(.00)(5)$.00 $ .31 $4.71 3.74% $262,000 1.58% 6.52% 455% 1994 .... 5.09 .40 (.17) .23 (.36) (.08) (.03) 4.85 4.11% 550,254 1.30% 7.10% 346% 1993 .... 5.00 .21 .09 .30 (.21) .00 - 5.09 6.17%(3) 315,844 .20%*(1)(2) 9.02%*(1)(2) 129% - ---------- * Net of fees deferred and expenses absorbed. (1) Annualized. (2) The ratios of expenses to average net assets and investment income-net to average net assets would have been 1.59% and 6.51%, respectively, for the year ended April 30, 1995, 1.41% and 6.99%, respectively, for the period ended April 30, 1994 and 1.59% and 7.62%, respectively, for the period ended April 30, 1993, if a portion of the Fund's expenses had not been deferred and absorbed. (3) Not annualized. (4) Calculated based on average shares outstanding. (5) Less than one cent per share.
7 BLANCHARD SHORT-TERM BOND FUND
Realized Dividends and to Unrealized Share- Gain Total holders Distri- Net Net Ratio of (Loss) from from Dividends butions Asset Asset Ratio of Net Net Asset Invest- on Invest- Invest- in excess from Value Total at end Net Investment Year Value at ment Invest- ment ment of net Realized at Invest- of Year Expenses Income to Ended Beginning Income ments Income Income Investment Gains End of ment (000 to Average Average Net Portfolio April 30 of Period --Net --Net Operations --Net Income --Net Period Return omitted) Net Assets Assets Turnover - -------- --------- ------ ------- ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- --------- 1995 ... $2.93 .15 $.00(3) $.15 $(.14) $(.00)(3) $(.00) $2.94 5.34% $23,000 1.38%(2) 4.80%(2) 84% 1994 ... 3.00 .17 (.06) .11 (.17) - (.01) 2.93 3.72% 42,381 .63%(2) 5.64%(2) 212% 1993 ... $3.00 0.00(3) 0.00(3) 0.00(3) 0.00(3) - (0.00)(3) $3.00 0.15%(4) 2,000 3.03%(1) 3.89%(1) 36% - ------------ (1) Annualized. (2) The ratios of expenses to average net assets and net investment income to average net assets would have been 2.13% and 4.05%, respectively, for the year ended April 30, 1995, 2.05% and 4.22%, respectively, for the year ended April 30, 1994, and 2.10% and 4.15%, respectively, for the period ended April 30, 1993, if a portion of the Fund's expenses had not been voluntarily deferred and absorbed by the prior manager and prior distributor. (3) Less than one cent per share. (4) Not annualized.
BLANCHARD WORLDWIDE EMERGING MARKETS FUND
Realized Dividends Distri- and to butions Unrealized Share- to Gain Total holders Share- Net Net Ratio of Ratio of (Loss) from from holders Asset Asset Net Net Net Asset Invest- on Invest- Invest- from Change Value Total at end Expenses Investment Year Value at ment Invest- ment ment Realized in Net at Invest- of Year to Income to Ended Beginning Income ments Income Income Gains Asset End of ment (000 Average Net Average Net Portfolio April 30 of Period --Net --Net Operations --Net --Net Value Period Return omitted) Assets Assets Turnover - -------- --------- ------ ------ ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- -------- 1995..... $7.98 $(.11) $(1.47) $1.58 $ - $ - $(1.58) $6.40 (19.80%) $12,000 3.59%(c) (1.44%)(c) 132% 1994(a).. 8.00 (.00)(d) (.02) (.02) - - (.02) 7.98 (.25%)(e) 8,042 3.07%(b)(c) (.10%)(b)(c) 0% - ----------- (a) Represents period from March 1, 1994 (commencement of the Fund's operations) to April 30, 1994. (b) Annualized. (c) The ratios of expenses to average net assets and net investment (loss) income to average net assets would have been 4.22% and (2.07%) respectively, for the year ended April 30, 1995 and 4.42% and (1.45%) respectively, for the period ended April 30, 1994 if a portion of the Fund's expenses had not been voluntarily waived and absorbed by the prior manager. (d) Less than one cent per share. (e) Not annualized.
8 BLANCHARD AMERICAN EQUITY FUND
Realized and Unrealized Total Net Net Ratio of Ratio of (Loss) from Asset Asset Net Net Net Asset Invest- on Invest- Tax Change Value Total at end Expenses Investment Year Value at ment Invest- ment Return in net at Invest- of Year to Income to Port- Ended Beginning Income ments Income of Asset End of ment (000 Average Net Average Net folio April 30 of Period --Net --Net Operations Capital Value Period Return omitted) Assets Assets Turnover - -------- --------- ------ ------ ---------- ------- --------- ------ ------- -------- ----------- ----------- -------- 1995 ... $ 9.42 $(.01)(DD) $ .45 $ .44 $(.23) .21 $9.63 4.83% $10,000 3.05%(1) (1.87%)(1) 45% 1994 ... 9.10 (.20)(DD) .52 .32 - .32 9.42 3.52% 13,970 3.00% (2.04%)(1) 97% 1993 ... 10.00 (.03)(DD) (.87) (.90) - (.90) 9.10 (9.0%)(3) 31,148 3.13%*(1)(2) (1.66%)*(1)(2) 49% - ------------ * Net of expense reimbursement. (1) The ratios of expenses to average net assets and net investment income to average net assets would have been 3.79% and (2.61%), respectively, for the year ended April 30, 1995, 3.00% and (2.05%), respectively for the year ended April 30, 1994, and 3.73% and (2.26%), respectively, for the period ended April 30, 1993, if a portion of the Fund's expenses had not been waived and absorbed. (2) Annualized. (3) Not annualized. (DD)Calculated based on average shares outstanding.
BLANCHARD FLEXIBLE TAX-FREE BOND FUND
Realized Dividends and to Unrealized Share- Gain Total holders Dividends Distri- Net Net Ratio of Ratio of (Loss) from from in excess butions Asset Asset Net Net Net Asset Invest- on Invest- Invest- of From Value Total at end Expenses Investment Year Value at ment Invest- ment ment Investment Realized at Invest- of Year to Income to Port- Ended Beginning Income ments Income Income Income Gains End of ment (000 Average Net Average Net folio April 30 of Period --Net --Net Operations --Net --Net --Net Period Return omitted) Assets Assets Turnover - -------- --------- ------ ------ ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- -------- 1995 ... $4.77 .24 .26 .50 (.23) (.01) _ $5.03 10.74% $19,000 1.00%*(2) 4.87%*(2) 170% 1994 ... 5.00 .18 (.20) (.02) (.18) - (.03) 4.77 (.48%)(3) 23,267 0%*(1)(2) 6.79%*(1)(2) 190% - ------------ * Net of fees waived and expenses absorbed. (1) Annualized. (2) The ratios of expenses to average net assets and net investment income to average net assets would have been 2.17% and 6.04%, respectively, for the year ended April 30, 1995 and 2.22% and 4.57%, respectively, for the period ended April 30, 1994, if the Fund's expenses had not been voluntarily waived and absorbed by the prior manager. (3) Not annualized.
BLANCHARD PRECIOUS METALS FUND, INC.
Realized and Distri- Distri- Unrealized tions to butions Gain Total Share- in Net Net Ratio of Ratio of (Loss) from holders Excess Asset Asset Net Net Net Asset Invest- on Invest- from of Tax Value Total at end Expenses Investment Year Value at ment Invest- ment Realized Realized Return at Invest- of Year to Income to Port- Ended Beginning Income ments Income Gains Gains of End of ment (000 Average Net Average Net folio April 30 of Period --Net --Net Operations --Net --Net Capital Period Return omitted) Assets Assets Turnover - -------- --------- ------ ------ ---------- ------- -------- --------- ------ ------- -------- ----------- ----------- -------- 1995 ... $8.73 $(.02) $(.41) $(.43) $(.03) $(1.06) $(.09) $7.12 (4.39%) $75,000 2.49% (1.48%) 116% 1994 ... 6.83 (.11)(f) 2.01(f) 1.90 - - - 8.73 27.8% 68,092 2.46% (1.21%) 174% 1993 ... 5.04 (.08)(f) 1.87B:(f) 1.79 - - - 6.83 35.5% 32,636 3.24% (1.46%) 66% 1992 ... 5.29 (.09)(f) (.16)(f) (.25) - - - 5.04 (4.7%) 20,900 3.09% (1.57%) 62% 1991 ... 6.30 (.08)(f) (.93)(f) (1.01) - - - 5.29 (16%) 24,924 3.05% (1.28%) 57% 1990 ... 7.19 (.03)(f) (.725)(f) (.755) (.03) (.105) (.135) 6.30 (10.9%) 31,539 2.95% (.40%) 56% 1989(c). 8.00 .02 (.83) (.81) - - - 7.19 (10.2%)(g) 25,837 3.99%(a)(b)(d) .77%(a)(b)(e) 21% - -------------- (a) Net of expense reimbursement. (b) Annualized. (c) Represents period from June 22, 1988 (commencement of the Fund's operations) to April 30, 1989. (d) During the first year (1989), the net expense ratio to average net assets would have been 4.03%, if a portion of the 12b-1 distribution and management fees had not been waived by the prior distributor and prior manager, respectively. (e) The investment income net ratio to average net assets would have been .72%, if a portion of the 12b-1 distribution and management fees had not been waived by the prior distributor and prior manager, respectively. (f) Calculated based on average shares outstanding--prior years' amounts restated for comparative purposes. (g) Not annualized.
9 THE FUNDS' INVESTMENT OBJECTIVES AND POLICIES The investment objectives and policies of each Fund are described below. Specific investment techniques that may be employed by the Funds are described in a separate section of this Prospectus and in each Fund's Statement of Additional Information. Our investment objectives and certain policies, except as noted, are fundamental and can only be changed by vote of a majority of the outstanding shares of a particular Fund. We may not always achieve our objectives, but will follow the investment standards described below. Blanchard Global Growth Fund The Fund seeks to provide long-term capital growth. Current income is incidental to the Fund's objective. The Fund attempts to achieve its objective through the implementation of the strategy outlined below. The Fund's investment policies reflect VCM's opinion that the U.S. economic system is characterized by various cycles affecting, among other things, business activities, inflation, interest rates, currencies and price levels and that by shifting its assets among the six investment sectors, the Fund can take advantage of investment opportunities created by such cycles. VCM believes that within each cycle, certain investment sectors offer more investment opportunities than others. Naturally, there can be no guarantee that VCM can predict business cycles with 100% accuracy or that the objective of the Fund can be achieved. When Fund management believes that market conditions warrant a temporary defensive position, it may invest up to 100% of the Fund's assets in cash, including foreign currencies, short-term instruments such as commercial paper, bank certificates of deposit, bankers' acceptances, or repurchase agreements for such securities and securities of the U.S. Government and its agencies and instrumentalities. VCM has identified the following six strategic investment sectors which have generally responded, both positively and negatively, to almost all major economic trends. A percentage of the Fund's assets need not be allocated into all sectors. The following illustrations indicate, in VCM's opinion, in what economic circumstances the six investment sectors might approach the Fund's maximum permitted allocation levels. The Fund may have zero percent allocated to any sector when the Global Allocation Strategist deems it appropriate. Percentage of Total Assets of the Fund in each Sector --------------------- Sectors Maximum ------- ------- U.S. Equities Sector ..................................... 65% Foreign Equities Sector ................................... 65% American Fixed Income Sector .............................. 65% Foreign Fixed Income Sector ............................... 65% Precious Metals Securities and Bullion Sector ............. 65% Emerging Markets Sector ................................... 15% Each sector is managed by a separate sector portfolio manager ("Sector Managers"). Generally, the services of the Sector Managers are not readily available to most individual investors because they manage primarily very large private or institutional accounts. The Global Allocation Strategist of the Fund determines what percentage of the Fund's total assets are to be allocated into the individual sectors within 10 the maximum percentages set forth above and makes changes in allocation percentages as investment and economic conditions change. Accordingly, the Fund will not be managed as a balanced portfolio and during the course of a business cycle the Fund may be invested in as few as two sectors. The strategy is to shift percentage allocation among the six investment sectors at the most advantageous time and price. VCM has intentionally separated the asset allocation function from the investment selection function. It has sought to identify and select specialists in each of the six investment sectors, as well as the allocation function, who have demonstrated success in their particular area of expertise. It is possible that an overlapping of investments among the six investment sectors may occur. For example, investments in U.S. equity securities are not limited only to the U.S. Equities sector as the Precious Metals Securities and Bullion sector may invest in common stocks of U.S. precious metals-related companies as well. Therefore, if the U.S. Equities sector was at its maximum allocation of 65% of the Fund's assets, and the Precious Metals Securities and Bullion sector had investments in U.S. common stocks of precious metals companies, the total assets of the Fund invested in U.S. equity securities could exceed 65%. U.S. Equities Sector. The Sector Manager is, Shufro, Rose & Ehrman. The Allocation Strategist will increase the allocation in the U.S. Equities sector to near the maximum level during periods of strong corporate earnings, stable economic growth, low interest rates, and low or declining inflation rates. The Allocation Strategist will reduce the allocation for this sector to near the minimum level during periods of rapidly rising or high interest rates, abruptly declining inflation, or uncertain economic conditions. In addition, the Sector Manager may invest in undervalued companies that may have profit potential regardless of overall economic conditions. Undervalued companies are, in the opinion of the Sector Manager, companies whose balance sheet, management ability, and product line or service are worth more on a collective basis than the market value of the company. The U.S. Equities sector is expected to perform well during periods of declining interest rates, average or high corporate profits and stable economic conditions. It will be invested primarily in common stocks of companies traded on national exchanges in the United States, and secondarily in preferred stocks or convertible securities traded on such exchanges. Securities are selected based on fundamental research of the earning power and management of companies and industries. Major emphasis is placed on stocks of companies considered by the U.S. Equities Sector Manager to have potential for long-term capital appreciation. Foreign Equities Sector. The Sector Manager, Fiduciary International, Inc., invests in publicly-traded equity securities of companies domiciled outside of the United States. This sector invests in non-U.S. companies whose securities are traded on exchanges located in the countries in which the issuers are principally based, including companies located in: Australia, Austria, Belgium, Canada, Denmark, France, Finland, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, New Zealand, Norway, Spain, Sweden, Switzerland and the United Kingdom. The sector will maintain investments in a minimum of five countries. When the Foreign Equities Sector Manager believes that the currency of a particular foreign country may suffer a substantial decline against the U.S. dollar, it may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of the Fund's portfolio securities denominated in such foreign currency. It may also enter into such contracts to protect against loss between trade and settlement dates resulting from changes in foreign currency exchange rates. Such contracts will also have the effect of limiting any gains to the Fund between trade and settlement dates resulting from changes in such rates. These contracts will be purchased for hedging purposes only. The decision to increase or decrease the percentage allocation to this strategic sector will depend on a combination of the following 11 factors: (1) specific opportunities in individual issues; (2) favorable economic, political and business conditions in individual countries; and (3) timely participation in specific worldwide industry groups, such as automobiles, electronics, oils, etc., irrespective of their location. While the pursuit of foreign currency gain for U.S. dollar-based investors is not a primary objective of this sector, currency profits may occur if investments in this sector take place during a period of dollar depreciation. For example, during periods of declining U.S. dollar exchange values, it may be possible to benefit from the decline by purchasing short-term foreign currency denominated instruments, as well as foreign currency denominated equities and bonds. There are certain risks in foreign securities that may not be present in domestic investments. American Fixed Income Sector. As fixed income securities have historically shown the greatest appreciation during periods of falling interest rates, the Sector Manager, Investment Advisors, Inc., intends to increase the allocation percentage in this sector during such periods. Conversely, the Sector Manager intends to de-emphasize this sector during periods of stable or rising interest rates. In the event of generalized worldwide deflation, similar to that experienced during the 1930's, the Sector Manager intends to increase the allocation of government securities in this sector to the maximum. This sector of the Fund invests in: 1. Corporate debt obligations rated at the time of purchase within the four highest investment grades assigned by Moody's, or Standard & Poor's. While obligations in these categories are generally deemed to have adequate to very strong protection of principal and interest, those rated within the lowest of these categories (i.e., Baa by Moody's and BBB by Standard & Poor's) may have speculative characteristics as well and may be more likely to experience a weakened capacity to make principal and interest payments during times of changing economic conditions or other circumstances than higher grade obligations. For a description of the ratings used by Moody's and Standard & Poor's, see Appendix A to this Prospectus. 2. Securities of, or guaranteed by, the United States Government, its agencies or instrumentalities. 3. Securities (payable in United States dollars) of, or guaranteed by, the government of Canada or of a province of Canada or any instrumentality or political subdivision thereof, such securities not to exceed 25% of the Fund's total assets. Foreign Fixed Income Sector. The Foreign Fixed Income Sector Manager, Fiduciary International, Inc., will purchase rated or unrated fixed income securities which, in its opinion, equate generally to United States standards of "investment grade" obligations. U.S. investment grade obligations are generally considered to be obligations of issuers having an issue of bonds rated within the four highest quality grades as determined by a nationally recognized statistical rating organization such as Moody's or Standard & Poor's. The Fund invests in publicly-traded common stocks of companies engaged in the exploration, refining, development, manufacture, production or marketing of precious metals. As fixed income securities have historically shown the greatest appreciation during periods of falling interest rates, the Sector Manager intends to increase the allocation percentage in this sector during such periods. Conversely, the Sector Manager intends to de-emphasize this sector during periods of stable or rising interest rates. The Sector Manager intends to maintain, in normal circumstances, a substantial portion of the Foreign Fixed Income sector's assets in high quality debt obligations denominated in a range of foreign currencies. This sector may engage in futures and options transactions to the extent permissible under the Fund's current investment guidelines. Precious Metals Securities and Bullion Sector. Prices of bullion and common stocks of precious metals-related companies have generally tended to rise during periods of accelerating inflation, and, to a 12 lesser extent, during periods of social, political and financial instability. The Sector Manager, Cavelti Capital Management, Ltd., intends to increase the allocation in the Precious Metals Securities and Bullion sector when it perceives that inflation is beginning to accelerate. The Sector Manager also intends to increase the allocation, although probably to a lesser extent than during strong inflationary periods, when destabilizing financial, political or social conditions arise outside of the United States. During periods of low inflation, stable economic and political conditions, and low or declining interest rates, it is likely that demand for precious metals will be low, the potential for appreciation small, and the risk of price erosion large; therefore, the allocation for this sector would tend to be close to the minimum level during these periods. While the Fund's investment policy is not to invest its assets in any one industry, it may invest up to 65% of its assets in this sector of the portfolio during strong inflationary periods, and to a lesser extent, during periods when social, political and financial instability warrant taking such a position. For the purposes of this sector, the definition of Precious Metals Securities is "publicly-traded common stocks of metal mining producer and non-producer companies that are engaged in the exploration, refining and development of gold, silver, palladium, and platinum; other companies that are engaged in the manufacture or production of products incorporating such precious metals, for example, jewelry, photographic supplies and medical equipment and supplies; and companies that are engaged in the marketing of precious metals or precious metals products. Such marketing companies may be in the industries named above or in separate industries that fall into the category of wholesale-retail trade." A company will be considered to be "engaged in" such activity if it derives more than 50% of its revenues from or devotes more than 50% of its assets to such activity. As so defined, the Fund may invest up to 65% of its assets in the Precious Metals Securities and Bullion sector provided that not more than 25% of the Fund's assets will be in any of the individual industries named above, as such industries are defined in the SIC/SEC Industries Code, and further provided that not more than 10% of the Fund's assets will be in Physical Precious Metals Investments, which are defined as gold, silver, platinum and palladium, through holdings in bullion or precious metals certificates or storage receipts representing precious metals. In particular, the Sector Manager may invest in (1) publicly-traded common stocks, (2) securities convertible into common stocks, such as convertible preferred stock, convertible debentures, convertible rights and warrants (to the extent permissible by the Fund's investment policies), and (3) debt securities of such companies, all of which are believed by the Sector Manager to have the potential for appreciation. Where the Precious Metals Securities and Bullion Sector Manager deems it appropriate, the Fund may, for purposes of this sector, engage in certain hedging transactions with options listed on foreign exchanges. Emerging Markets Sector. Emerging countries overall have experienced a higher gross domestic product ("GDP") growth rate than industrialized countries in the last ten years. The Sector Manager, Martin Currie Inc., believes that emerging countries, as a group, will continue to experience growth rates in excess of those experienced by industrialized countries, and therefore will allocate up to a maximum of 15% of the Fund's net assets in this sector. In addition to the normal determinants of interest rates, inflation, economic growth and currency movements, country selections and weighings in emerging growth markets are determined by developmental trends, credit ratings, the political environment, market liquidity, progress towards privatization and the degree of foreign investor interest. In addition to emphasizing industries which are crucial to the development trend in a country and assessing financial reporting standards and the availability of public information, stock selection is based on a fundamental analysis of specific criteria including (i) quality of management; (ii) stock fundamentals (strong earnings growth and profit potential, positive cash flow, sound 13 balance sheet, geographical sales and profit spread, and good marketability in shares); and (iii) price and timing. An emerging country is any country that the International Bank for Reconstruction and Development (more commonly known as the World Bank) has determined to have a low or middle income economy. There are currently over 130 countries which are considered to be emerging countries, approximately 40 of which currently have stock markets. These countries generally include every nation in the world except the United States, Canada, Japan, Australia, New Zealand and most nations located in Western Europe. Currently investing in many emerging countries is not feasible or may involve unacceptable political risks. The Emerging Markets sector will focus its investments on those emerging market countries in which the Sector Manager believes the economies are developing strongly and in which the markets are becoming more sophisticated. An emerging country equity security is defined as common stock, preferred stock (including convertible preferred stock), bonds, notes and debentures convertible into common or preferred stock, stock purchase warrants and rights, equity interests in trusts and partnerships and American, Global or other types of Depository Receipts of companies: (i) the principal securities trading market for which is in an emerging country; (ii) that alone or on a consolidated basis derive 50% or more of their annual revenue from either goods produced, sales made or services performed in emerging countries; or (iii) that are organized under the laws of, and with a principal office in, an emerging country. Determinations as to eligibility will be made by the Sector Manager based upon publicly available information and inquiries made to the companies. Depository Receipts may not necessarily be denominated in the same currency as the underlying securities into which they may be converted. In addition, the issuers of the stock of unsponsored Depository Receipts are not obligated to disclose material information in the United States and, therefore, there may not be a correlation between such information and the market value of the Depository Receipts. While the foregoing represent economic scenarios that often occur, markets are not entirely predictable,and do not always react in the same way to the same economic stimuli. Therefore, there is no assurance that such patterns will always occur in a standardized and predictable format. Consideration of historical patterns of economic and market interaction is only one of the factors that will be used when making allocation and investment decisions. The selection of investments for the Fund also will be guided by research and investment data. We can provide no assurance that the premises on which this investment strategy is based will prove to be correct or that the Fund will actually achieve its objective. Blanchard American Equity Fund The investment objective of the Fund is to provide long-term growth of capital. The Fund's Portfolio Adviser is Provident Investment Counsel, Inc. The Fund will invest in equity securities, consisting of common stocks and securities having the characteristics of common stocks, specifically convertible preferred stocks, convertible debt securities and warrants. Such equity securities will be issued by companies which are (a) organized under U.S. law, (b) for which the principal securities trading market is in the U.S. or (c) which derive a significant proportion (at least 50%) of their revenues or profits from goods produced or sold, investments made, or services performed in the U.S., or which have at least 50% of their assets situated in the U.S. The Fund will invest at least 65% and under normal circumstances expects to invest at least 80% of its assets in such equity securities. In selecting investments for the Fund, the Portfolio Adviser will select equity securities of companies of various sizes which are currently experiencing a rate of earnings growth greater than the average of such rate for all companies included in Standard & Poor's 500-Stock Index. It is expected that approximately half of the equity securities in which the Fund will invest will be listed and traded on the New York Stock Exchange, and the remainder will be traded on the National 14 Association of Securities Dealers' NASDAQ system or are otherwise traded over the counter. The Portfolio Adviser supports its selection of individual securities through intensive research and uses qualitative and quantitative discipline to determine when securities should be sold. Short-Term Investments. During those times when the Portfolio Adviser does not believe that substantially all of the Fund's assets should be invested in equity securities, all or part of the Fund's assets may be invested temporarily in short-term investments. Under normal market conditions, it is expected that investments in such short-term instruments may range from zero (fully invested) to 30% of the Fund's assets. The short-term investments that may be purchased by the Fund consist of high quality debt obligations maturing in one year or less from the date of purchase, such as U.S. government securities, certificates of deposit, bankers' acceptances and commercial paper. High quality means the obligations have been rated at least A-1 by Standard & Poor's or Prime-1 by Moody's, or have an outstanding issue of debt securities rated at least A by Standard & Poor's or Moody's, or are of comparable quality in the opinion of the Portfolio Adviser. Short-term investments also include repurchase agreements with respect to the high quality debt obligations listed above. See "Repurchase Agreements" below. Blanchard Precious Metals Fund, Inc. The Fund's primary investment objective is to provide long-term capital appreciation and preservation of purchasing power through investments in physical precious metals and securities of companies involved with precious metals. A secondary objective is to reduce the risk of loss of capital and decrease the volatility often associated with precious metals investments by changing the allocation of the Fund's assets from Precious Metals Securities to Physical Precious Metals Investments and/or investing in short-term instruments and government securities during periods when the Portfolio Adviser, Cavelti Capital Management Ltd., believes the precious metal is markets may experience declines. For purpose of this Fund, the term "Precious Metals Securities" refers to the debt and equity securities of domestic and foreign companies listed on domestic and foreign exchanges which are directly involved in the exploration, development, mining, refining, manufacturing, dealing or marketing of precious metals or precious metals products. A company will be considered to be "involved in" such activity if it derives more than 50% of its revenues from or devotes more than 50% of its assets to such activity. The Fund may invest in (1) publicly-traded common stocks, (2) securities convertible into common stocks, such as convertible preferred stock, convertible debentures, convertible rights and warrants (to the extent permissible by the Fund's investment policies), and (3) debt securities of such companies, all of which are believed by the Portfolio Adviser to have the potential for appreciation. In addition, when the Portfolio Adviser believes that market conditions warrant, the Fund may invest up to 100% of its assets in certain short-term instruments. The Fund may, from time to time, invest up to 5% of its assets in unrated foreign debt securities which are judged by the Portfolio Adviser to be of at least comparable quality to lower-rated U.S. debt securities (usually defined as Baa or lower by Moody's or BBB or lower by Standard & Poor's). The selection of unrated foreign debt securities will depend to a great extent on the credit analysis performed by the Portfolio Adviser. Since it is possible that the Fund could have up to 100% of its total assets in equity securities of domestic and foreign companies directly involved in the exploration, development, mining, refining, manufacturing, dealing or marketing of precious metals or precious metals products, the Fund may be subject to greater risks and greater market fluctuations than funds with a more diversified general equity portfolio. The Fund may invest up to 49% of its total assets in physical precious metal of gold, silver, platinum or palladium through holdings in bullion or precious metals certificates or storage receipts representing the physical metals. When the Fund invests in precious metals certificates and storage receipts, it receives certificates evidencing ownership of specific amounts of precious metals bullion, instead of taking physical possession of the bullion represented by the certificate. The Fund relies on the issuers of such documents to 15 maintain the underlying precious metal on deposit. A default by any of the issuers could expose the Fund to loss of the metal on deposit. The Fund will purchase certificates from institutions where the certificate is 100% backed by physical precious metals in the possession of the institutions and enter into such transactions only with banks, brokers, dealers and clearinghouses which have assets of over $1 billion and in the Portfolio Adviser's opinion, have a high degree of creditworthiness. The creditworthiness of the issuers will be monitored by the Portfolio Adviser on an ongoing basis. The Fund will not invest in coins. The Fund may purchase contracts for forward delivery of physical precious metals. Forward contracts for precious metals are contracts between the Fund and institutions dealing in precious metals for the future receipt or delivery of metals at a price fixed at the time of the transaction. While some of the Fund's investments may earn interest or dividends, the Fund is not designed for investors seeking income. The Fund's investment strategy calls for different approaches to the precious metals markets in different economic and investment conditions. As Precious Metals Securities have historically out-performed the price of the physical metals during periods of generally rising precious metals prices, the Fund will ordinarily tend to emphasize Precious Metals Securities over Physical Precious Metals Investments during such periods. However, to the extent that the current behavior of precious metals markets does not conform to historical patterns at any given time, investments of the Fund will be placed in those markets believed by the Portfolio Adviser to have the most promising potential for appreciation. Conversely, during periods of stable or falling precious metals prices, physical precious metals have generally held their value better than Precious Metals Securities. Therefore, during those periods, the Fund will tend to emphasize investments in Physical Precious Metals Investments. As the Fund can invest in all four precious metals; gold, silver, platinum and palladium, the Portfolio Adviser will attempt to capitalize on price differentials in the metals markets. Although the Portfolio Adviser believes that prices of gold, silver, platinum or palladium generally tend to move in the same direction at the same time, with gold often setting the pace, experience has proven that this is not always the case. The Fund, therefore, may emphasize some metals over others when the Portfolio Adviser believes it is advisable to do so. There is no assurance that the Portfolio Adviser's forecasts of precious metals prices and the resulting allocation of the Fund's assets among precious metals or between Precious Metals Securities and Physical Precious Metals Investments will always be correct. When the Portfolio Adviser believes that precious metals prices may suffer declines, it may protect against market risk by increasing the Fund's cash position. Under normal conditions, the Fund will have at least 65% of its total assets invested in Precious Metals Securities and Physical Precious Metals Investments. Under other circumstances, the Fund may invest up to 100% of its assets in short-term instruments, including commercial paper, bank certificates of deposit, bankers' acceptances and securities of the U.S. Government and its agencies and instrumentalities as well as in cash and cash equivalents dominated in foreign currency. The Portfolio Adviser believes that precious metals and securities of precious metals related companies continue to offer excellent prospects for capital appreciation and protection of your purchasing power, during any economic environment, and especially during periods of inflation, as well as periods of political and economic instability. The market for precious metals is worldwide; therefore, precious metals prices are subject to many political, social and economic influences, often resulting in high volatility. See "Investment Techniques and Associated Risks-Precious Metals and Precious Metals Securities" for further details. As physical precious metals earn no income, appreciation in the market price of gold and other precious metals is the sole manner in which the Fund is able to realize gains on these investments. Furthermore, the 16 Fund encounters storage and transaction costs in connection with its ownership of physical precious metals which are higher than those attendant to the purchase, holding and disposition of more traditional types of investments. The production and marketing of gold and precious metals may be affected by the action of certain governments and changes in existing governments. For example, the mining of gold is highly concentrated in a few countries. Economic and political conditions prevailing in these countries may have a direct effect on the production and marketing of newly produced gold and sales of central bank gold holdings. It is expected that a majority of gold mining companies in which the Fund will invest will be located within the United States and Canada. For a further discussion on this subject, including certain risk considerations and limitations regarding investments in South African issuers, see "Investment Techniques and Associated Risks-Precious Metals and Precious Metals Securities." Blanchard Short-Term Global Income Fund The Fund's objective is to provide high current income with minimum risk of principal and relative stability of net asset value. To achieve this objective, the Portfolio Adviser, Lombard Odier International Portfolio Management Limited, will invest primarily in a portfolio of debt obligations rated in the four highest rating categories of nationally recognized rating services denominated in various currencies, which have average remaining maturities not exceeding three years (as the useful life of individual pools of assets underlying certain obligations in which the Fund may invest may at times be of a shorter duration than the stated maturity of the obligation itself, the Fund may consider the useful life of such underlying assets as the maturity of the obligation owned by the Fund). The Fund may also invest up to 10% of its assets in securities rated Ba by Moody's or BB by Standard & Poor's (or if unrated, determined by the Portfolio Adviser to be of equivalent quality), in repurchase agreements, cash or cash equivalents or such other debt instruments as is consistent with its investment objective. In addition, the Fund is authorized, for the purpose of increasing its yield or hedging its currency exposure, to engage in any one or more of the specialized investment techniques and strategies described below under the caption "Certain Investment Techniques and Policies". The Fund will seek investment opportunities in foreign, as well as domestic, securities markets. While the Fund normally will maintain a substantial portion of its assets in debt securities denominated in foreign currencies, it is anticipated that, in normal circumstances, the Fund's assets will include securities in at least three countries, including the United States. The Fund is designed for the investor who seeks a higher yield than a money market Fund and less fluctuation in net asset value than a longer term bond fund. There can be no assurance that the Fund's yield will at all times exceed that of a money market fund. To the extent domestic short-term interest rates are higher than domestic long-term or foreign short or long-term interest rates, and the Fund is not substantially invested in U.S. Dollar denominated money market instruments, the Fund's yield may not be higher than that of a money market fund. In pursuing its investment objective, the Fund seeks to minimize credit risk and fluctuations in net asset value by investing only in short-term debt obligations. Although the Fund may invest in debt obligations having average remaining maturities of up to three years, it reserves the right to invest without limitation in debt obligations having substantially shorter remaining maturities during times of rapidly changing currency exchange rates or other uncertain market or economic conditions, or in anticipation of such times. The Fund also reserves the right to invest in floating and variable rate demand obligations that provide for a periodic adjustment in the interest rate paid on the obligation and/or permit the holder to demand payment upon a specified number of days' notice of the unpaid principal balance and accrued interest either from the issuer or by drawing on a bank letter of credit, a guarantee or insurance issued with respect to such obligation. 17 The Fund's portfolio is managed in accordance with a global investment strategy, which means that the Fund's investments will be allocated among securities denominated in the U.S. Dollar and the currencies of a number of foreign countries and, within each such country, among different types of debt securities. The Fund's exposure with respect to each currency is adjusted based on Fund management's perception of the most favorable markets and issuers. In this regard, the percentage of assets invested in securities of a particular country or denominated in a particular currency will vary in accordance with Fund management's assessment of the relative yield and appreciation potential of such securities and the relationship of a country's currency to the U.S. Dollar. Fundamental economic strength, credit quality and interest rate trends are the principal factors considered by Fund management in determining whether to increase or decrease the emphasis placed upon a particular type of security or industry sector within the Fund's investment portfolio. The Fund will not invest more than 25% of its total assets in debt obligations denominated in a single currency other than the U.S. Dollar. The attractive returns currently available from short-term foreign currency denominated debt obligations can be adversely affected by changes in exchange rates. The Portfolio Adviser believes that the use of foreign currency hedging techniques, including "crosshedges", can help protect against declines in the U.S. Dollar value of income available for distribution to shareholders and declines in the net asset value of the Fund's shares resulting from adverse changes in currency exchange rates. For example, the return available from securities denominated in a particular foreign currency would diminish in the event the value of the U.S. Dollar increased against such currency. Such a decline could be partially or completely offset by an increase in value of a crosshedge involving a forward currency contract, where such contract is available on terms more advantageous to the Fund than a contract to sell the currency in which the position being hedged is denominated. It is the Portfolio Adviser's belief that crosshedges can therefore provide significant protection of net asset value in the event of a general rise in the U.S. Dollar against foreign currencies. However, a crosshedge cannot protect completely against exchange rate risks, and if Fund management is incorrect in its judgment of future exchange rate relationships, the Fund could be in a less advantageous position than if such a hedge had not been established. In addition to the U.S. Dollar, such currencies include, among others, the Australian Dollar, the Austrian Schilling, British Pound Sterling, Canadian dollar, Danish Kroner, Dutch Guilder, European Currency Unit ("ECU"), Finnish Markka, French Franc, German Mark, Italian Lira, Japanese Yen, New Zealand Dollar, Norwegian Kroner, Portuguese Escudo, Spanish Peseta, Swedish Krona and the Swiss Franc. An issuer of debt securities purchased by the Fund may be domiciled in a country other than the country in whose currency the instrument is denominated. The Fund seeks to minimize investment risk by primarily limiting its portfolio investments to debt securities rated no lower than Baa by Moody's or BBB by Standard & Poor's. However, the Fund may invest up to 10% of its assets in securities rated Ba by Moody's or BB by Standard & Poor's (or, if unrated, determined by the Portfolio Manager to be of equivalent quality). Accordingly, with respect to the debt securities and other investments described above, the Fund's portfolio consists only of: (i) debt securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities; (ii) obligations issued or guaranteed by a foreign government or any of its political subdivisions, authorities, agencies, or instrumentalities, or by supranational entities (which are described below) (collectively referred to as "Foreign Government Obligations"), which are rated no lower than Ba by Moody's or BB by Standard & Poor's or, if unrated, determined by Fund management to be of equivalent quality; (iii) corporate debt securities rated no lower than Ba by Moody's or BB by Standard & Poor's or, if unrated, determined by Fund management to be of equivalent quality; (iv) certificates of deposit and banker's acceptances issued or guaranteed by, or time deposits maintained at, banks, including foreign branches or subsidiaries of U.S. depository institutions ("Eurodollar" obligations) or U.S. branches or subsidiaries of foreign depository institutions ("Yankeedollar" 18 obligations) or foreign branches or subsidiaries of foreign depository institutions, having total assets of more than $500 million and determined by Fund management to be of high quality; (v) commercial paper rated A-1 or A-2 by Standard & Poor's, Prime-1 or Prime-2 by Moody's, Fitch-1 or Fitch-2 by Fitch Investors Services, Inc., Duff 1 or Duff 2 by Duff & Phelps Inc. or, if not rated, issued by U.S. or foreign companies having outstanding debt securities rated AAA, AA or A by Standard & Poor's, or Aaa Aa or A by Moody's and determined by Fund management to be of high quality, and loan participation interests having a remaining term of or not exceeding one year in loans extended to such companies by commercial banks or other commercial lending institutions whose long-term debt and commercial paper is rated AAA or AA by Standard & Poor's or Aaa or Aa by Moody's ("a High Quality Rating"); (vi) repurchase agreements with respect to the foregoing debt securities; and (vii) futures contracts, options on futures contracts, options on foreign currencies, options on portfolio securities, and forward foreign currency exchange contracts. To minimize investment risk, the Fund may only invest (a) up to 25% of its assets in securities rated no lower than A by Moody's or Standard & Poor's (or, if unrated, determined by the Portfolio Adviser to be of equivalent quality); (b) up to 10% of its assets in securities rated no lower than Ba by Moody's or BB by Standard & Poor's (or, if unrated determined by the Portfolio Manager to be of equivalent quality); and (c) (up to 10% of its assets in any such Foreign Government Obligations issued in any one country. The medium to lower-rated and unrated Foreign Government Obligations in which the Fund invests tend to offer higher yields than higher-rated securities with the same maturities. Debt obligations rated lower than A by Standard & Poor's or Moody's tend to have speculative characteristics and generally involve more risk of loss of principal and income than higher-rated securities. For a description of the various ratings used by the ratings agencies, see Appendix A. The Fund may invest without limitation in commercial paper which is indexed to certain specific foreign currency rates. The terms of such commercial paper provide that its principal amount is adjusted upwards or downwards (but not below zero) at maturity to reflect change in the exchange rate between two currencies while the obligation is outstanding. The Fund will purchase such commercial paper with the currency in which it is denominated and, at maturity, will receive interest and principal payments thereof in that currency, but the amount of principal payable by the issuer at maturity will change in proportion to the change (if any) in the exchange rate between the two specified currencies between the date the instrument is issued and the date the instrument matures. While such commercial paper entails the risk of loss of principal, the potential for realizing gains as a result of changes in foreign currency exchange rates enables the Fund to hedge (or crosshedge) against a decline in the U.S. Dollar value of investments denominated in foreign currencies while providing an attractive money market rate of return. The Fund will purchase such commercial paper for hedging purposes only, not for speculation. The staff of the SEC is currently considering whether the purchase of this type of commercial paper would result in the issuance of a "senior security" within the meaning of the Investment Company Act of 1940 (the "1940 Act"). The Portfolio Adviser believes that such investments do not involve the creation of such a senior security but nevertheless has undertaken, pending the resolution of this issue by the staff, to establish a segregated account with respect to the Fund's investments in this type of commercial paper and to maintain in such account cash not available for investment or U.S. Government Securities or other liquid high quality debt securities having a value equal to the aggregate principal amount on outstanding commercial paper of this type held by the Fund. The Fund may invest in debt securities issued by the supranational organizations such as: the World Bank, which was chartered to finance development projects in developing member countries; the European Community, which is a twelve-nation organization engaged in cooperative economic activities; the European Coal and Steel Community, which is an economic union of various European nations' steel and coal industries; the Asian Development Bank, which is an international development bank established to lend funds, promote investment and provide technical assistance to member nations in the Asian and 19 Pacific regions; and other such organizations, including the European Investment Bank and the Inter-American Development Bank. The foregoing entities and other such supranational organizations are not considered by the Fund or its management to be "banks" for purposes of computing investment restrictions regarding non-diversification or concentration policies and, as a result, the debt securities issued by such supranational organizations will not be included as banks for determination of compliance with the percentage limitations of such investment policies. The Fund may invest in debt securities denominated in the ECU, which is a "basket" consisting of specified amounts of the currencies of certain of the twelve member states of the European Community. The specific amounts of currencies comprising the ECU may be adjusted by the Council of Ministers of the European Community to reflect changes in relative values of the underlying currencies. The Portfolio Adviser does not believe that such adjustments will adversely affect holders of ECU-denominated obligations or the marketability of such securities. European supranationals, in particular, issue ECU-dominated obligations. Blanchard Short-Term Bond Fund The investment objective of the Fund is to provide a high level of current income consistent with preservation of capital by investing primarily in short-term investment grade debt securities. The Fund's Portfolio Adviser is OFFITBANK. The Fund is designed for investors seeking higher yields than are available from money market funds, but who also want more price stability than is offered by longer-term bond funds. Under normal market conditions, the Fund will invest at least 80% of its assets in a broad range of U.S. debt securities of all types. The Fund may invest up to 20% of the value of its assets in securities of foreign issuers denominated in foreign currency and not publicly traded in the United States. Under normal market conditions, at least 65% of the value of the Fund's assets will be invested in investment-grade bonds, which are considered to be those rated at least Baa by Moody's or at least BBB by Standard & Poor's or, if unrated, deemed to be of comparable quality by the Portfolio Adviser. The Fund may invest less than 35% of its assets in lower-quality debt securities if the Portfolio Adviser deems that such securities present attractive investment opportunities. The Fund will not invest in debt securities rated lower than Caa by Moody's and CCC by Standard & Poor's, or, if unrated, of comparable quality in the Portfolio Adviser's opinion. Debt securities rated Baa by Moody's and BBB by Standard & Poor's are considered investment grade obligations which lack outstanding investment characteristics and may have speculative characteristics as well. Debt securities rated Caa by Moody's and CCC by Standard & Poor's are considered to have predominantly speculative characteristics with respect to capacity to pay interest and repay principal and to be of poor standing. See "Risk Factors-Lower Quality Debt Securities" below for a discussion of certain risks, and Appendix A. Although it is intended that the average maturity of the Fund's portfolio will be three years or less, the Fund retains the flexibility to increase the average maturity to up to five years in times when abnormal market conditions warrant temporary measures. Accordingly, the Fund's average maturity may vary, based on the Portfolio Adviser's analysis of interest rate trends and other data. In general, the Fund's average maturity will tend to be shorter when the Portfolio Adviser expects interest rates to rise and longer when it expects interest rates to decline. The Fund may invest in individual securities with terms to maturity of greater than five years if the Fund's portfolio contains sufficient short-term securities so that the weighted average maturity complies with the above-stated policy. As the useful life of individual pools of assets underlying certain obligations in which the Fund may invest may at times be of a shorter duration than the stated maturity of the obligation itself, the Fund may consider the useful life of such underlying assets as the maturity of the obligation owned by the Fund. 20 Under normal market conditions, the Fund does not expect to have a substantial portion of its assets invested in money market instruments. However, when the Portfolio Adviser determines that adverse market conditions exist, the Fund may adopt a temporary defensive posture and hold cash or invest its entire portfolio in money market instruments. In addition, during times of international political or economic uncertainty, most or all of the Fund's investments may be made in the U.S. and denominated in U.S. dollars. To the extent the Fund is so invested, the Fund's investment objective may not be achieved. The Fund will invest in bonds, notes, mortgage securities, asset-backed securities, government and government agency obligations, zero coupon securities and convertible securities, and short-term obligations such as banker's acceptances, certificates of deposit, repurchase agreements and commercial paper, in any proportion that the Portfolio Adviser determines is appropriate and in the best interest of shareholders. The Fund may invest in U.S. Government securities and in options, futures contracts and repurchase transactions with respect to such securities. See "Additional Investment Information". The Fund may invest up to 20% of its assets in international securities consisting of debt obligations and other fixed-income securities, in each case denominated in non-U.S. currencies or composite currencies, including: debt obligations issued or guaranteed by foreign national, provincial, state, municipal or other governments with taxing authority or by their agencies or instrumentalities; debt obligations of supranational entities (described below); debt obligations of the U.S. Government issued in non-dollar securities; and debt obligations and other fixed-income securities of foreign and U.S. corporate issuers (non-dollar denominated). When investing in international securities, the Fund is not limited to purchasing debt securities rated at the time of purchase by Moody's or Standard & Poor's. However, the Fund is limited to the extent that it may not invest more than 34.9% of its assets in lower quality debt securities. In making international securities investments, the Portfolio Adviser may consider, among other things, the relative growth and inflation rates of different countries. The Portfolio Adviser may also consider expected changes in foreign currency exchange rates, including the prospects for central bank intervention, in determining the anticipated returns of securities denominated in foreign currencies. The Portfolio Adviser may further evaluate, among other things, foreign yield curves and regulatory and political factors, including the fiscal and monetary policies of such countries. The Fund may invest in any country where the Portfolio Adviser sees potential for high income. It presently expects to invest primarily in non-dollar denominated securities of issuers in the industrialized Western European countries; in Canada, Japan, Australia and New Zealand; and in Latin America. The Fund may invest up to 10% of its assets in the debt securities of issuers in emerging market countries. The Fund may invest, without limitation, in unrated debt securities issued by foreign governments, their agencies and instrumentalities, where the foreign government, its agency or instrumentality is rated less than Baa by Moody's or less than BBB by Standard & Poor's, provided, however, that the Portfolio Adviser has determined through its own credit analysis that the credit characteristics of any such unrated security are equivalent to those of a security rated at least Baa by Moody's or BBB by Standard & Poor's. To the extent that the Portfolio Adviser has not made any such determination, such unrated debt securities will be deemed to have the rating assigned by Moody's or Standard & Poor's to the governmental entity. To the extent that such securities are deemed to be rated less than Baa by Moody's or less than BBB by Standard & Poor's, investment in such securities will be subject to the under 35% limitation on investment in lower quality debt securities. The obligations of foreign governmental entities, including supranational issuers, have various kinds of government support. Obligations of foreign governmental entities include obligations issued or guaranteed 21 by national, provincial, state or other governments with taxing power or by their agencies. These obligations may or may not be supported by the full faith and credit of a foreign government. Supranational entities include international organizations designated or supported by governmental entities to promote economic reconstruction or development and international banking institutions and related government agencies. Examples include the International Bank for Reconstruction and Development (the World Bank), the European Steel and Coal Community, the Asian Development Bank and the Inter-American Development Bank. The governmental agencies, or "stockholders," usually make initial capital contributions to the supranational entity and in many cases are committed to make additional capital contributions if the supranational entity is unable to repay its borrowings. Each supranational entity's lending activities are limited to a percentage of its total capital (including "callable capital" contributed by members at the entity's call), reserves and net income. The Fund does not have a policy of concentrating investments in supranational entities. Blanchard Flexible Tax-Free Bond Fund The Fund's investment objective is to provide a high level of current interest income exempt from Federal income tax consistent with the preservation of principal. The Fund will invest at least 65% of its assets in municipal bonds, except when maintaining a temporary defensive position. The Fund's Portfolio Adviser is The United States Trust Company of New York. The Fund invests in municipal obligations which are determined by the Portfolio Adviser to present minimal credit risks. As a matter of fundamental policy, except during temporary defensive periods, the Fund will maintain at least 80% of its assets in tax-exempt obligations, including the alternative minimum tax. (This policy may not be changed without the vote of the holders of a majority of the Fund's outstanding shares.) However, from time to time on a temporary defensive basis due to market conditions, the Fund may hold uninvested cash reserves or invest in taxable obligations in such proportions as, in the opinion of the Portfolio Adviser, prevailing market or economic conditions may warrant. Uninvested cash reserves will not earn income. Interest income from certain short-term holdings may be taxable to shareholders as ordinary income. The municipal obligations purchased by the Fund will consist of: (1) municipal bonds rated "A" or better by Moody's or by Standard & Poor's or, in certain instances, municipal bonds with lower ratings if they are deemed by the Portfolio Adviser to be comparable to A-rated issues; (2) municipal notes rated "MIG-2" or better ("VMIG-2" or better in the case of variable rate notes) by Moody's or "SP-2" or better by Standard & Poor's and (3) municipal commercial paper rated "Prime-2" or better by Moody's or "A-2" (collectively, "Municipal Obligations"). If not rated, securities purchased by the Fund will be of comparable quality to the above ratings as determined by the Portfolio Adviser under the supervision of the Board Members. A discussion of Moody's and Standard & Poor's rating categories is contained in Appendix A. The Fund may purchase and sell municipal bond index and interest rate futures contracts as a hedge against changes in market condition. See "Risks" below. The Fund may also invest in securities issued by money market funds which are investment companies that invest in high-quality, short-term securities and that determine their net asset value per share based on the amortized cost or penny-rounding method. Such securities will be acquired by the Fund within the limits prescribed by the 1940 Act. By investing in shares of money market funds, the Fund pays a portion of the operating and management expenses of such money market funds, as well as its own operating and management expenses. Investors should consider the tax consequences of an investment by the Fund in money market funds distributing taxable income. However, it is a policy of the Fund to maximize the percentage of distributions to shareholders that are not subject to Federal income taxes. 22 Blanchard 100% Treasury Money Market Fund The Fund seeks to provide the highest level of current income as is consistent with the preservation of capital and maintenance of liquidity. The Portfolio Adviser for the Fund is VCM. The Fund attempts to achieve its investment objective by investing exclusively in U.S. dollar denominated, short-term obligations of the U.S. Treasury maturing in 13 months or less with a dollar weighted average portfolio maturity of 90 days or less, provided that such obligations are deemed to present minimal credit risks pursuant to procedures adopted by the Board Members. The Fund will not invest in repurchase agreements, certificates of deposit of commercial banks or savings and loan associations, nor will it invest in obligations issued or guaranteed by agencies or instrumentalities of the U.S. Government (such as the Federal Savings and Loan Insurance Corp., the Export-Import Bank of the United States, the Farmer's Home Administration, the Federal Farm Credit Bureaus, etc.), or in corporate debt securities. Although the Fund's shares are not insured or guaranteed by the U.S. Government, the Treasury obligations in which the Fund invests are general obligations of the U.S. Government, which are believed by many to be among the safest investments available with respect to credit risk. The Treasury obligations in which the Fund will invest may not yield as high a level of current income as longer term or lower grade securities which generally have less liquidity and experience greater price fluctuation. Blanchard Flexible Income Fund The investment objective of the Fund is to provide high current income while seeking opportunities for capital appreciation. The Portfolio Adviser for the Fund is OFFITBANK. The Fund intends to invest in the following fixed income securities markets: U.S. Government Securities. This consists of debt obligations of the U.S. Government and its agencies and instrumentalities and related options, futures contracts and repurchase agreements. Investment Grade Fixed Income Securities. This consists of investment grade fixed income securities, including mortgage related and asset backed securities. High Yield Securities. This consists of higher yielding (and, therefore, higher risk), lower rated U.S. corporate fixed income securities. International Fixed Income Securities. This consists of obligations of foreign governments, their agencies and instrumentalities and other fixed income securities denominated in foreign currencies or composite currencies including: debt obligations issued or guaranteed by foreign national, provincial, state, municipal or other governments with taxing authority or by their agencies or instrumentalities; debt obligations of supranational entities (see discussion in "Blanchard Short Term Bond Fund" above); debt obligations of the U.S. Government issued in non-dollar securities; and debt obligations and other fixed income securities of foreign and U.S. corporate issuers (non-dollar denominated). The Fund is not limited to purchasing debt securities rated at the time of purchase by Moody's or Standard & Poor's. The Fund may invest in any country where the Portfolio Adviser sees potential for high income. It presently expects to invest primarily in non-dollar denominated securities of issuers in the industrialized Western European countries; in Canada, Japan, Australia and New Zealand; and in Latin America. In making international fixed income securities investments, the Portfolio Adviser may consider, among other things, the relative growth and inflation rates of different countries. The Portfolio Adviser may also consider expected changes in foreign currency exchange rates, including the prospects for central bank intervention, in determining the anticipated returns of securities denominated in foreign currencies. The Portfolio Adviser 23 may further evaluate, among other things, foreign yield curves and regulatory and political factors, including the fiscal and monetary policies of such countries. The Fund may also invest up to 25% of its assets in the fixed income securities of issuers in emerging market countries. It is the policy of the Fund not to invest more than 10% of its assets in any one emerging market country, except that the Fund may invest up to 15% of its assets in fixed income securities of issuers in Mexico. For additional information on each of these securities markets see "Additional Investment Information." The Portfolio Adviser believes that the ability to invest the Fund's assets among these markets, as opposed to investing in any one, may enable the Fund to enhance current income and increase opportunities for capital appreciation while taking risk to principal into consideration. The Fund may invest up to 35% of its assets in lower quality fixed income securities. There is no limit on the percentage of Fund assets invested in any of the fixed income markets except for High Yield Securities which is limited to less than 35%, and further limited to the extent of any lower quality fixed income securities held in the International Fixed Income Securities portfolio. At least 65% of the Fund's total assets generally will be invested in income producing securities; however, the Fund expects that substantially all of its total assets will be invested in income-producing securities, together with certain futures, options and foreign currency contracts and other investments described below. When the Portfolio Adviser determines that adverse market conditions exist, the Fund may adopt a temporary defensive posture and hold cash or invest its entire portfolio in money market instruments. In addition, during times of international political or economic uncertainty, most or all of the Fund's investments may be made in the U.S. and denominated in U.S. dollars. For a complete discussion of the types of investments in which the Fund will invest-see "Additional Investment Information" below. Blanchard Worldwide Emerging Markets Fund The Fund is designed for investors wishing to participate in the investment opportunities available in smaller, emerging markets around the world. The Portfolio Adviser for the Equity Securities sector of the Fund is Martin Currie Inc. The Portfolio Adviser for the Fixed Income Securities sector of the Fund is OFFITBANK. The Portfolio Advisers believe that the economies of these emerging markets will continue to have among the world's fastest rates of economic growth over the next decade. In many instances, the growth in these countries is brought on by a move away from governmental intervention in the marketplace, and an aggressive move towards free market capitalism. Their development is enhanced by a high degree of infrastructure development brought about by increased trade, accelerating demand for consumer products and a growing middle class. Generally, these economies are characterized by large, hard-working labor pools, low labor costs and a growing middle class. Many companies in these emerging market countries are experiencing rising productivity and profit growth due to increased focus on higher value added, increased demand for their products from internal and external markets, more profitable product lines and enhanced capital investment in technology. In addition, because many governments are opening capital markets to foreign investors, foreign capital is beginning to be attracted to these countries, further fueling growth to levels which are generally higher than in the U.S. and other more developed countries. As a result, the stock markets in many of these emerging market countries have, in recent years, outperformed our own. Additionally, the Fund is able to invest in emerging market fixed income securities. The Portfolio Advisers believe that this will be advantageous to investors for three reasons: (1) shareholders will receive income distributions, when available, on a quarterly basis, (2) the Fund may seek capital appreciation from its fixed income component, and (3) by diversifying the Fund's portfolio between both equities and fixed income, the Fund expects to be able to enjoy the risk-reducing benefit of diversifying between asset classes. When an emerging market is less developed, and therefore carries more risk, emerging market issuers 24 have to offer higher yields on fixed income securities in order to attract the capital needed to continue to develop. Once an emerging market issuer has shown the ability to service its debt, it may be able to reduce yields, thereby providing existing holders of its fixed income securities with opportunities for capital appreciation. Investing directly in foreign securities is usually impractical for individual investors. Investors frequently find it difficult to arrange purchases and sales, and to obtain current market, industry or economic data. The Portfolio Advisers' experience in emerging market investing, coupled with the convenience and service advantages associated with a U.S. based mutual fund, including free telephone transfers and liquidations, shareholder services, professional management and diversification between a broad basket of securities, may make the Fund a more appropriate emerging markets investment vehicle for individual investors. The investment objective of the Fund is capital appreciation and current income. The Fund's investment objective is deemed fundamental and may not be changed without shareholder approval. The Fund seeks to achieve its objective by investing primarily in equity and fixed income securities in emerging markets around the world. There can be no assurance that the Fund's investment objective will be achieved. The proportions invested in each of the Fund's two portfolio sectors will be varied from time to time in accordance with Fund management's interpretation of economic conditions and investment opportunities. Under normal circumstances, however, the Fund expects to maintain a minimum of 65% in equity and equity-related securities. To the extent that the Fund's assets are not invested in securities of issuers whose principal activities are in emerging markets, the remainder of the assets maybe invested in: (i) equity or fixed income securities of corporate or governmental issues located in industrialized countries; and (ii) money market instruments. An emerging market is any country that the World Bank has determined to have a low or middle income economy and may include every country in the world except the United States, Australia, Canada, Japan, New Zealand and most countries located in Western Europe such as Belgium, Denmark, France, Germany, Great Britain, Italy, the Netherlands, Norway, Spain, Sweden and Switzerland. Under normal conditions, the Fund will invest at least 65% of its total assets in securities of issuers whose principal activities are in emerging markets. However, for temporary defensive purposes, the Portfolio Advisers may invest less than 65% of the Fund's assets in securities of issuers whose principal activities are in emerging markets, in which case the Fund may invest in U.S. Treasury securities and high quality fixed income securities. The Fund may invest indirectly in emerging markets by investing in other investment companies. Due to restrictions on direct investment by foreign entities in certain emerging market countries, investment in other investment companies may be the most practical or the only manner in which the Fund can invest in the securities markets of certain emerging market countries. Such investments may involve the payment of premiums above the net asset value of such issuers' portfolio securities, are subject to limitations under the 1940 Act, are constrained by market availability and may constitute passive foreign investment companies for Federal income tax purposes. As a shareholder in an investment company, the Fund would bear its ratable share of that investment company's expenses, including its advisory and administration fees. The Portfolio Advisers have agreed to waive their management (advisory) fees with respect to the portion of the Fund's assets invested in shares of other open-end investment companies. The Fund would continue to pay its own management fees and other expenses with respect to its investments in shares of a closed-end investment company. The Portfolio Adviser for Fixed Income Securities may invest all of the fixed income sector's total assets in lower-quality fixed income securities if the Portfolio Adviser deems that such high yield/high risk securities present attractive investment opportunities. Most fixed income securities in emerging markets, even 25 government obligations, are rated lower than investment grade by U.S. rating services. "Investment grade" fixed income securities are those rated within the four highest ratings categories of Standard & Poor's or Moody's or, if a security is unrated, determined to be of comparable quality. Securities rated BBB by Standard & Poor's and Baa by Moody's are investment grade fixed income securities but may have speculative characteristics. Many emerging market fixed income securities are not rated by U.S. ratings agencies. Investment in non-investment grade fixed income securities involves a high degree of risk and can be speculative. See "Risk Factors and Special Considerations" for a discussion of certain risks. For temporary defensive purposes, the Portfolio Advisers may invest less than 65% of the Fund's assets in securities of issuers whose principal activities are in emerging markets, in which case the Fund may invest in U.S. Treasury securities and high quality fixed income securities. The Fund may invest up to 15% of its total assets in repurchase agreements, borrow money and enter into forward foreign currency exchange contracts and foreign currency futures contracts, as well as purchase put or call options on foreign currency. See "Certain Investment Strategies and Policies". MANAGEMENT OF THE FUNDS Board of Trustees/Directors. The Board of Trustees of Blanchard Funds and the Board of Directors of BPMF (the "Boards" or the "Board Members") are responsible for managing the business affairs of the Funds and for exercising all of the powers of the Funds except those reserved for the shareholders. The Executive Committee of the Boards handle the Boards' responsibilities between meetings of the Boards. Manager. VCM is responsible for managing the Funds and overseeing the investment of their assets, subject at all times to the supervision of the Board Members. In addition, VCM selects, monitors and evaluates the Portfolio Advisers. VCM will review the Portfolio Advisers' performance records periodically, and will make changes if necessary, subject to Board Member and Shareholder approval. Management Fees. VCM receives an annual management fee at annual rates equal to percentages of the relevant Fund's average net assets as follows: Blanchard Global Growth Fund- 1.00% of the Fund's first $150 million of average daily net assets, .875% of the Fund's average daily net assets in excess of $150 million but not exceeding $300 million and .75% of the Fund's average daily net assets in excess of $300 million. Blanchard 100% Treasury Money Market Fund-.50% of the first $500 million of the Fund's average daily net assets, .475% of the Fund's average daily net assets in excess of $500 million but not exceeding $1 billion, plus .45% of the Fund's average daily net assets in excess of $1 billion; Blanchard Short-Term Global Income Fund-.75%; Blanchard American Equity Fund-1.10%; Blanchard Precious Metals Fund, Inc. -1% of the first $150 million of the Fund's average daily net assets, .875% of the Fund's average daily net assets in excess of $150 million but not exeeding $300 million and .75% of the Fund's average daily net assets in excess of $300 million. Blanchard Flexible Income Fund-.75%; Blanchard Short-Term Bond Fund-.75%; Blanchard Flexible Tax-Free Bond Fund-.75% and Blanchard Worldwide Emerging Markets Fund-1.25%. The portion of the fee based upon the average daily net assets of the Fund shall be accrued daily at the rate of 1/365th of the applicable percentage applied to the daily net assets of the Fund. The management contract provides for the voluntary waiver of expenses by VCM from time to time. VCM can terminate this voluntary waiver of expenses at any time with respect to a Fund at its sole discretion. VCM has also undertaken to reimburse the Funds for operating expenses in excess of limitations established by certain states. 26 VCM's Background. Virtus Capital Management, Inc., a Maryland corporation formed in 1995, is a wholly owned subsidiary of Signet Banking Corporation. Signet Banking Corporation is a multi-state, multi-bank holding company which has provided investment management services since 1956. VCM, which is a registered investment adviser, manages, in addition to the Funds, The Virtus Funds, three equity common trust funds with $39 million in assets and three fixed income common trust funds with $221 million in assets. For the fiscal year ended April 30, 1995 the prior manager received from each Fund a monthly fee at the following annual rates: BGGF: 1.00%; BTMMF: .42%; BSTGIF: .71%; BFIF: .74%; BSTBF: .17%; BWEMF: .59%; BAEF: .31%; BFTFBF: .11%; and BPMF: 1.00% of average daily net assets. These fees (except for BTMMF) are higher than the fees paid by most investment companies because of the complexity of managing these types of Funds. VCM has conditioned its right to receive a portion of any earned but deferred fees from BFIF and BSTBF and to receive reimbursement for absorbed expenses (measured on a rolling two-year period, starting from the date the portion of the fee is deferred and/or the expenses are absorbed) upon these Funds reaching and then maintaining the following specified levels of net assets for a period of 30 continuous days (excluding assets exchanged into a Fund after June 1, 1993 from other funds in the Blanchard Group of Funds), provided that such reimbursement would not cause the Fund's expenses in such year to exceed 1.75%: Specified Level of Conditional Portion of Earned But Fund's Net Assets Deferred Fees to be Received ------------------ --------------------------------- BFIF $600 million 20% $630 million 20% $660 million 20% $690 million 20% $720 million 20% ---- 100% BSTBF $ 50 million 25% $ 60 million 25% $ 70 million 25% $ 80 million 25% ---- 100% 27 PORTFOLIO ADVISORY SERVICES The Portfolio Advisers. To provide portfolio advisory services for the Funds, VCM has entered into sub-advisory agreements with the Portfolio Advisers set forth below. The Portfolio Advisers have extensive experience in investing and managing large private and institutional accounts. Under the terms of each sub-advisory agreement, the Portfolio Adviser has discretion to purchase and sell securities for that Fund, except as limited by such Fund's investment objective, policies and restrictions. Although each Portfolio Adviser's activities are subject to general oversight by VCM and the Board Members, selection of specific securities in which the Fund may invest are made by the Portfolio Adviser. Blanchard Global Growth Fund Shufro Rose & Ehrman ("Shufro") manages the U.S. Equities Sector of the Fund. Shufro is a registered investment adviser. Founded in 1938, Shufro is a member of the New York and American Stock Exchanges. It is among the oldest of those firms specializing in the management of investment portfolios. As of December 31, 1994, Shufro managed assets of more than $1.2 billion from private and institutional accounts. Shufro's investment philosophy is one of "fundamentals". This involves selecting securities backed by assets, finances and current earning power. Shufro's principals conduct research as well as portfolio management, including examination of source materials such as annual and other corporate reports, published speeches by the company officers, and other pertinent data. In addition, Shufro's principals conduct visits to companies to attain depth of understanding not achieved solely through inspection of written materials. Robert Weiss, a General Partner of Shufro, with more than 30 years of experience as a portfolio manager, is responsible for the day-to-day management of this sector's portfolio. The Foreign Equities Sector and the Foreign Fixed Income Sector are managed by Fiduciary International, Inc., a New York corporation that was organized in 1982 as Fir Tree Advisers, Inc. Fiduciary International, Inc. has also been chosen by the Fund to perform the duties of Global Allocation Strategist. Fiduciary International, Inc. is a wholly-owned subsidiary of Fiduciary Investment Corporation, which, in turn, is a wholly-owned subsidiary of Fiduciary Trust Company International. Fiduciary Trust Company International was chartered in 1931 as a New York State bank and is headquartered in New York City. This sector is managed by a committee headed by Mr. Jeremy H. Biggs, Vice Chairman and Chief Investment Officer. The American Fixed Income Sector is managed by Investment Advisers, Inc. of Minneapolis, Minnesota, a registered investment adviser established in 1947. As of December 31, 1994, it managed over $14 billion in assets. Investment Advisers, Inc. furnishes investment advice to pension and profit sharing trusts, religious, educational, and charitable trusts, investment companies, municipalities and individuals. Larry R. Hill, an Executive Vice President of Investment Advisers, Inc., with more than 10 years of experience as a Fixed Income Portfolio Manager, is responsible for the day-to-day management of this sector's portfolio. The Precious Metals Securities and Bullion Sector Manager is managed by Cavelti Capital Management, Ltd., of Toronto, Canada. Cavelti Capital Management, Ltd. is a Canadian money management firm specializing in bullion and precious metals mining shares and is a registered investment adviser with the SEC. Peter C. Cavelti, the company's President, has extensive investment experience in the field of precious metals and the firm's clients include government agencies, financial institutions, mining companies and Canadian mutual funds. Cavelti Capital Management, Ltd. also acts as Portfolio Adviser to BPMF. 28 Martin Currie Inc., a member of the Martin Currie Group, manages the Emerging Markets sector. Based in Edinburgh, the Martin Currie Group is one of Scotland's leading international equity houses and has experience and expertise in emerging markets. The Martin Currie Group currently manages over $5.5 billion in global assets and has been involved in managing investment portfolios for over 100 years. Martin Currie Inc., incorporated in 1978, is an investment adviser registered with the SEC and currently manages over $1.15 billion in global assets. Currently, the Martin Currie Group operates its investment business through four companies: in North America, through Martin Currie Inc. (the Sector Manager), and in the U.K., Martin Currie Investment Management, Martin Currie Unit Trusts and Martin Currie Private Clients. All are wholly-owned subsidiaries of Martin Currie Limited. An asset allocation committee headed by Mr. James Fairweather, a director and senior portfolio manager with Martin Currie, with more than 10 years of experience as a portfolio manager, coordinates the company's investments in emerging markets. The committee determines asset allocation and country weighting for emerging markets and Mr. Fairweather, together with Mr. Tristan Clube (also a director and senior portfolio manager), select stocks in conjunction with members of regional investment teams. Martin Currie Inc. also acts as portfolio adviser to BWEMF. VCM has chosen Fiduciary International, Inc. to act as the Global Allocation Strategist for the Fund. As such, Fiduciary International has a global allocation committee headed by Mr. Jeremy H. Biggs, Vice Chairman and Chief Investment Officer, whose role is to review, evaluate and allocate the percentages in which the total assets of the Fund will be divided among its six investment sectors, subject to review by VCM and the Board Members. The allocations for each sector may be changed at any time. Allocations will vary depending on a variety of factors, such as economic and market conditions, interest rates, currency fluctuations, inflationary or deflationary expectations, geopolitical circumstances and other factors. The ability of the Fund to achieve its investment objective will be dependent in part on the success of the Global Allocation Strategist in anticipating the onset, duration and termination of broad economic cycles. Failure to anticipate the onset or termination of such cycles could result in the assets of the Fund being disproportionately weighted toward one sector at the expense of another. VCM feels that Fiduciary International, Inc. is uniquely qualified for the job of Global Allocation Strategist. Fiduciary International, Inc. is a registered investment adviser with the SEC and has been engaged in the business of providing investment advisory services since 1982. In addition to its role as Global Allocation Strategist, Fiduciary International, Inc. has been chosen to manage the Foreign Fixed Income and Foreign Equities sectors of the Fund. Fiduciary International, Inc. was founded in 1931 and currently manages over $30 billion in global assets for large institutional and corporate accounts as well as those of wealthy individuals. Clients include the United Nations pension fund, Princeton University and Duke University. Mr. Jeremy H. Biggs, Vice Chairman and Chief Investment Officer of Fiduciary International, Inc., oversees the portfolio allocation process for the Fund. Mr. Biggs is a graduate of Yale University and has done postgraduate work at the London School of Economics. Mr. Biggs has extensive experience in global investing and in finance. Mr. Biggs is supported by a team of researchers and analysts. Fiduciary International, Inc.'s method of security analysis includes credit analysis to gauge the creditworthiness of issuers of securities, analysis of economic background, industry analysis, balance sheet and income statement analysis and assessment of the macro-economic environment and the outlook for the currencies in the countries where the companies operate. In addition, Fiduciary International, Inc. 29 may use outside sources of information, including economic consultants, technical industry specialists and market technicians. The Sub-Advisory Agreements. The sub-advisory agreements between VCM and the Sector Managers provide for payment by VCM of annual fees, payable to the Sector Managers on a monthly basis. The aggregate of fees payable to the Sector Managers for the services they provide, as a group, equals approximately 35% of the management fees paid to VCM by the Fund. For a detailed description of the sub-advisory agreements and of the Fund's expenses, see "Management of the Funds" in the Fund's Statement of Additional Information. Blanchard Short-Term Global Income Fund VCM has retained Lombard Odier International Portfolio Management Limited, Norfolk House, 13 Southampton Place, London WC1A 2AJ, England ("Lombard Odier") to provide portfolio advisory services to the Fund. Lombard Odier is the institutional investment management arm of Geneva-based Lombard Odier & Cie, one of the oldest and largest private Swiss banks, founded in 1798. The Lombard Odier Group currently manages in excess of $30 billion and has nearly 200 years experience in global fixed income investment management. Lombard Odier is registered as an investment adviser with the SEC. Paul Abberley, a Director of Lombard Odier, has more than 8 years of experience as a portfolio manager and is responsible for the day-to-day management of the Fund's portfolio. The Portfolio Adviser has retained WLO Global Management, as sub-adviser, to assist in the investment management of the Fund pursuant to a Sub-Advisory Agreement, and subject to the direction of the Manager, the Portfolio Adviser and the Board of Trustees of the Fund. Under the Sub-Advisory Agreement, the Sub-Adviser has primary responsibility for providing investment advice to the Fund and managing the domestic (U.S.) investment of the Fund's assets, while the Portfolio Adviser retains responsibility for international investments. WLO Global Management, a partnership between the Lombard Odier and Western Asset groups of companies, was established in 1992 to offer international and global fixed income portfolio management services to U.S. plan sponsors and foreign institutions. WLO Global Management is registered with the Securities and Exchange Commission as an investment adviser. WLO Global Management is structured to combine the proven expertise of two independent yet mutually compatible firms: Western Asset (for U.S. domestic fixed-income management) and Lombard Odier (for non-dollar fixed income management). The California-based partner, Western Asset Management International, is registered with the Securities and Exchange Commission as an investment adviser. As of December 31, 1994, the Group managed $12.8 billion of U.S. fixed-income assets. The Sub-Advisory Agreement. The sub-advisory agreement between VCM and Lombard Odier provides for the payment by VCM to Lombard Odier of a monthly fee at the annual rate of .35% of the first $10 million of the Fund's average daily net assets; .30% of the next $10 million of average daily net assets; .25% of the next $10 million of average daily net assets; .20% of the next $10 million of average daily net assets; and .15% of average daily net assets in excess of $40 million. 30 Blanchard Short-Term Bond Fund Blanchard Flexible Income Fund VCM has retained OFFITBANK, 520 Madison Avenue, New York, New York 10022 (the "Sub-Adviser") to provide portfolio advisory services to the Funds. OFFITBANK, a New York State chartered trust bank, is the continuation of the business of Offit Associates, Inc., a registered investment adviser founded in December, 1982. The firm converted to a trust bank in July, 1990. The core business of OFFITBANK is portfolio management for institutions, non-profit organizations and wealthy family groups. OFFITBANK specializes in fixed income management and offers its clients a complete range of fixed income investments in capital markets throughout the world. OFFITBANK currently manages in excess of $6 billion in assets. Jack D. Burks, Managing Director of OFFITBANK, has over 10 years of experience in Fixed Income Portfolio Management and is responsible for the day-to-day management of the Funds' portfolio. The Sub-Advisory Agreements. The sub-advisory agreements between VCM and OFFITBANK, provide for the payment by VCM to OFFITBANK of a monthly fee at the annual rate of .30% of the first $25 million of each Fund's average daily net assets; .25% of the next $25 million of average daily net assets; and .20% of average daily net assets in excess of $50 million. Blanchard Flexible Tax-Free Bond Fund VCM has retained The United States Trust Company of New York ("U.S. Trust") to provide portfolio advisory services to the Fund. U.S. Trust, a New York State chartered bank and trust company established in 1853, currently manages in excess of $30 billion in assets. U.S. Trust is a financial services company that specializes in asset management, private banking, fiduciary and securities services. Kenneth J. McAlley, an executive vice president of U.S. Trust, has over ten years of expertise in Municipal Obligation portfolio management and is responsible for the day-to-day management of the Fund's Portfolio. Mr. McAlley is a nationally recognized expert in municipal bond investment strategy and has been favorably profiled in publications such as Barrons, Forbes and Financial World. The Sub-Advisory Agreement. Pursuant to the sub-advisory agreement between VCM and U.S. Trust, VCM has agreed to pay U.S. Trust a monthly fee at the annual rate of .20% of the Fund's average daily net assets. Blanchard American Equity Fund VCM has retained Provident Investment Counsel ("Provident"), 300 North Lake Avenue, Pasadena, California 91101-4922, as the Portfolio Adviser to provide portfolio advisory services. The Portfolio Adviser is a corporation that traces its origins to an investment partnership formed in 1951. On February 15, 1995 Provident was acquired by, and became a wholly owned subsidiary of, United Asset Management Corp. The Portfolio Adviser currently manages over $14.3 billion and has nearly 40 years experience in equity management. The Portfolio Adviser is registered as an investment adviser with the SEC. Jeffrey Miller, a Managing Director of Provident, has more than 20 years of experience as a portfolio manager and is responsible for the day-to-day management of the Fund's portfolio. 31 The Sub-Advisory Agreement. The sub-advisory agreement between VCM and Provident, provides for the payment by VCM to Provident of a monthly fee at the annual rate of .50% of the first $150 million of the Fund's average daily net assets; .45% of the next $100 million of average daily net assets; .40% of the next $150 million of average daily net assets; and .35% of average daily net assets in excess of $400 million. Blanchard Worldwide Emerging Markets Fund Martin Currie Inc. provides portfolio advisory services for the Equity Securities sector of the Fund. For a discussion of Martin Currie Inc. see "Blanchard Global Growth Fund" above. OFFITBANK provides portfolio advisory services for the Fixed Income Securities sector of the Fund. For a discussion of OFFITBANK see "Blanchard Short-Term Bond Fund" above. The Sub-Advisory Agreements. Pursuant to the sub-advisory agreement between VCM and Martin Currie, VCM, not the Fund, has agreed to pay Martin Currie a monthly fee at the annual rate of .50% of the first $150 million of the equity sector's average daily net assets and .40% of the sector's average daily net assets in excess of $150 million. Pursuant to the sub-advisory agreement between VCM and OFFITBANK, VCM, not the Fund, has agreed to pay OFFITBANK a monthly fee at the annual rate of .45% of the first $150 million of the fixed income sector's average daily net assets and .35% of the sector's average daily net assets in excess of $150 million. Blanchard Precious Metals Fund, Inc. Cavelti Capital Management, Ltd. provides portfolio advisory services for the Fund. For a discussion of Cavelti Capital Management, Ltd. see "Blanchard Global Growth Fund" above. The Sub-Advisory Agreement. The sub-advisory agreement between VCM and Cavelti provides for payment by VCM of annual fees, payable to Cavelti on a monthly basis. For the services provided by Cavelti, VCM pays a fee of .30% of the average daily net assets of the Fund on the first $150 million, plus .2625% of the Fund's average net assets in excess of $150 million but less than $300 million, plus .225% of the Fund's average net assets in excess of $300 million. HOW TO INVEST You may purchase shares of any Fund from Federated Securities Corp., the Funds' principal Distributor. You may also purchase shares from broker-dealers who have entered into a dealer agreement with the Distributor at net asset value which is computed once daily for BAEF and BTMMF as of the close of the New York Stock Exchange (currently 4:00 p.m., New York time) and for the other Funds as of the close of the options exchanges (normally 4:15 P.M. New York time). If your order is received after the above times, your shares will be purchased at the net asset value on the next business day. Each Fund's net asset value per share is determined by dividing the value of that Fund's net assets by the total number of its shares outstanding. Each Fund determines the net asset value of its shares on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in its securities to affect materially its net asset value per share. 32 For all Funds other than BTMMF the minimum initial investment requirement is $3,000 and the minimum initial investment requirement for qualified pension plans (IRAs, Keoghs, etc.) is $2,000. The minimum initial investment in BTMMF is $1,000 which is reduced to $500 for qualified pension plans. The minimum investment requirement for additional investments in all of the Funds is at least $200 per investment. (The foregoing minimum investment requirements may be modified or waived at any time at our discretion.) Purchases By Mail To purchase shares of a Fund by mail, simply send a completed Application (included with this Prospectus or obtainable from the Fund), to the Blanchard Group of Funds, c/o Mutual Funds Service Company, P.O. Box 2798, Boston, Massachusetts 02208-2798, together with a check payable to the Blanchard Group of Funds in payment for the shares. Mutual Funds Service Company is an affiliate of United States Trust Company of New York. If you need assistance in completing the application, call 1-800-829-3863. All purchases must be made in U.S. dollars and checks must be drawn on a United States bank. Payment for shares may not be made by third party checks; however, second party checks are acceptable when properly endorsed. We reserve the right to limit the number of checks for one account processed at one time. If your check does not clear, your purchase will be cancelled and you could be liable for any losses or fees incurred. Payments transmitted by check are accepted subject to collection at full face amount. Your purchase order becomes effective when it is received in proper form by the Fund's Transfer Agent. A purchase order will not become effective until it is received in proper form by the Transfer Agent. Purchases By Wire. You may also purchase shares by bank wire. For opening new accounts in this manner, please call 1-800-829-3863 (toll free) before wiring your funds, and furnish the following information: the account registration and address, and your taxpayer identification number (for individuals, a Social Security number). When making additional investments by wire to your existing accounts, please provide your account numbers. You must include your name and telephone number, the amount being wired and the name of the wiring bank with both new and existing account purchases. Initial purchases by wire must be followed by a completed Application within seven days. You should instruct your bank to wire Federal funds: United States Trust Company of New York, 114 West 47th Street, New York, New York 10036 ABA #021001318 Credit Account #20-7324-2, indicating the name of the Fund, your account number and the account registration. Automatic Investment Plans. Regular monthly purchases of shares may be made by direct deposit of Social Security and certain other government checks into your account. Fund shares may be purchased at regular intervals selected by you by automatic transferral of funds from a bank checking account that you may designate. All such purchases require a minimum of $100 per transaction. Call (1-800-829-3863) for information and forms required to establish these Plans. Electronic Funds Transfers (EFT)--Subsequent investments may be made by electronic transfer of funds from an account maintained in a bank or other domestic financial institution that is an Automated Clearing House member (ACH). To enroll in this program, you must file an application with the Blanchard 33 Group of Funds by calling 1-800-829-3863. You may begin transferring funds under the program only after 15 days from the date your EFT Application is received by the transfer agent, Mutual Funds Service Co. You must direct the institution to transmit immediately available funds through the Automated Clearing House to U.S. Trust Co. of New York ABA #021001318, CR A/C #20-7324-2 with instructions to credit your Fund account. The instructions must specify your Fund account registration and your Fund account number. Redemption proceeds will be on deposit in your designated account at an Automated Clearing House member bank ordinarily two days after receipt of the redemption request. Direct deposit of monthly dividends or systematic disbursements from your account will be on deposit in your designated account at an Automated Clearing House member bank ordinarily two days after a dividend payment or disbursement is effected. General Information All ordinary income, dividends and capital gain distributions, if any, are automatically reinvested at net asset value in additional Fund shares unless we receive written notice from you, at least 30 days prior to the record day of such distribution, requesting that your dividends and distributions be distributed to you in cash. See "Tax Matters". We reserve the right to suspend the offering of any Fund shares for a period of time. We also reserve the right to reject any purchase order. No share certificates will be issued for shares unless requested in writing. In order to facilitate redemptions and transfers, most shareholders elect not to receive certificates. Shares are held in unissued form by the Transfer Agent. Shares for which certificates have been issued cannot be redeemed, unless the certificates are received together with the redemption request in proper form. Share certificates are not issued for fractional shares. INVESTOR SERVICES Automatic Withdrawal Plan If you purchase $10,000 or more of Fund shares, you may establish an Automatic Withdrawal Plan to authorize a specified dollar amount to be paid periodically to a designated payee. Under this Plan, all income dividends and capital gains distributions will be reinvested in shares in your account at the applicable payment dates' closing net asset value. Your specified withdrawal payments are made monthly or quarterly (on or about the 10th day) in any amount you choose, but not less than $100 per month or $300 quarterly. Please note that any redemptions of your shares, which may result in a gain or loss for tax purposes, may involve the use of principal, and may eventually use up all of the shares in your account. Such payments do not provide a guaranteed annuity and may be terminated for any shareholder by a Fund if the value of the account drops below $10,000 due to transfer or redemption of shares. In such a case, the shareholder will be notified that the withdrawal payments will be terminated. The cost of administering the Automatic Withdrawal Plan for the benefit of shareholders is a Fund expense. 34 Retirement Plans We offer a Prototype Pension and Profit Sharing Plan, including Keogh Plans, IRAs SEP-IRA Plans, IRA Rollover Accounts and 403(b) Plans. Plan support services are available by calling 1-800-829-3863. Exchange Privilege You may exchange your Fund shares for shares of another Fund in the Blanchard Group of Funds on the basis of relative net asset values per share at the time of exchange. No fees are charged when you exchange from one Fund to another within the Blanchard Group of Funds. Before making an exchange, you should read the Prospectus concerning the Fund into which your exchange is being made. To request an exchange by telephone, simply call 1-800- , prior to 4:00 P.M. New York time. Exchanges can be made in this manner only after you have completed and sent to the Transfer Agent the telephone exchange authorization form that is included on the New Account Application accompanying this Prospectus and only if your account registration has not changed within the last 30 days. It is the Funds' policy to mail to you at your address of record, within five business days after any telephone call transaction, a written confirmation statement of the transaction. All calls will be recorded for your protection. As a result of the Funds' policy, neither a Fund nor its transfer agent will be responsible for any claims, losses or expenses for acting on telephone instructions that they reasonably believe to be genuine. Since you may bear the risk of loss in the event of an unauthorized telephone transaction, you should verify the accuracy of telephone transactions immediately upon receipt of your confirmation statement. Exchanges can only be made between accounts with identical account registration and in states where shares of the other Funds are qualified for sale. We do not place any limit on the number of exchanges that may be made and charge no fee for affecting an exchange. The dollar amount of an exchange must meet the initial investment requirement of the Fund into which the exchange is being made. All subsequent exchanges into that Fund must be at least $1,000. We may modify or suspend the Exchange Privilege at any time upon 60 days' written notice. Any exchange of shares is, in effect, a redemption of shares in one Fund and a purchase of the other fund. You should consider the possible tax effects of an exchange. To prevent excessive trading between Funds to the disadvantage of other shareholders, we reserve the right to modify or terminate this Privilege with respect to any shareholder. Check-Writing Privilege. If you are a shareholder of BSTGIF, BFIF, BSTBF or BTMMF (other than IRAs, Keoghs and other qualified pension plan shareholders), you may elect a service which allows you to write an unlimited number of checks, at no charge, in any amount of $250 or more which will clear through the Transfer Agent. If the amount of your check exceeds the value of the shares in your account, your check will be returned and a $10 fee deducted from your account. You may not use the Check-Writing Privilege to close out your account as you will not be able to ascertain the exact account balance of your account on the date your check clears. To close out your account completely, you should use the telephone or mail redemption procedures described below. Stop orders may be placed on checks for a fee of $10. For further information on this service, call the Distributor. The payee of a check may cash or deposit it in a bank, however checks cannot be presented in person at a branch office of the Transfer Agent for cash. When a check is presented to the Transfer Agent for payment, 35 it will cause the Fund to redeem a sufficient number of shares to cover the amount of the check. You will continue to earn daily income until the check is presented to the Transfer Agent for payment. A completed Purchase Application must be received by the Transfer Agent before the Withdrawal Plan, Exchange or Check-Writing Privileges may be used. HOW TO REDEEM You may redeem your shares on any business day at the next determined net asset value calculated after your redemption request has been accepted by the Transfer Agent as described below. By Telephone. You may redeem your shares by telephone if you call the Funds' Transfer Agent at 1-800-829-3863, prior to 4:15 P.M., New York time (4:00 P.M. New York time for BAEF and BTMMF). All calls will be recorded. Redemptions of Fund shares can be made in this manner only after you have executed and filed with the Transfer Agent the telephone redemption authorization form which may be obtained from your Fund or the Transfer Agent. You may elect on the telephone redemption authorization form to have a redemption in any amount of $250 or more mailed either to your registered address, to your bank account, or to any other person you may designate. Should you wish to review these instructions, simply complete and file a new telephone redemption authorization form. There is no charge for this service. Neither your Fund nor the Transfer Agent will be responsible for any claims, losses or expenses for acting on telephone instructions that they reasonably believe to be genuine. See "Investor Services--Exchange Privilege," for additional information with respect to losses resulting from unauthorized telephone transactions. You may also request, by placing a call to the applicable telephone number set forth above, redemption proceeds to be wired directly to the bank account that you have designated on the authorization form. The minimum amount that may be redeemed in this manner is $1,000. A check for proceeds of less than $1,000 will be mailed to your address of record. The Funds do not impose a charge for this service. However, the proceeds of a wire redemption may be subject to the usual and customary charges imposed by United States Trust Company of New York for the wiring of funds. Under extraordinary market conditions, it may be difficult for you to redeem your shares by telephone. Under these circumstances, you should consider redeeming your shares by mail, as described below. By Mail. All other redemption requests should be made in writing to the Blanchard Group of Funds, c/o Mutual Funds Service Company (an affiliate of United States Trust Company of New York), P.O. Box 2798, Boston, Massachusetts 02208-2798, the Funds' Transfer Agent. Where share certificates have been issued, the certificates must be endorsed and must accompany the redemption request. Signatures on redemption request for amounts in excess of $25,000 and endorsed share certificates submitted for redemption must be accompanied by signature guarantees from any eligible guarantor institution approved by the Transfer Agent in accordance with its Standards, Procedures and Guidelines for the Acceptance of Signature Guarantees ("Signature Guarantee Guidelines"). Eligible guarantor institutions generally include banks, broker-dealers, credit unions, national securities exchanges, registered securities association, clearing agencies and savings associations. All eligible guarantor institutions must participate in the Securities Transfer Agents Medallion Program ("STAMP") in order to be approved by the Transfer Agent pursuant to the Signature Guarantee Guidelines. Copies of the Signature Guarantee Guidelines and 36 information on STAMP can be obtained from the Transfer Agent at (800) 462-9102. Signatures on redemption requests for any amount must be guaranteed (as described above) if the proceeds are not to be paid to the registered owner at the registered address, or the registered address has changed within the previous 60 days. The letter of instruction or a stock assignment must specify the account number and the exact number of shares or dollar amount to be redeemed. It must be signed by all registered shareholders in precisely the same way as originally registered. The letter of instruction must also include any other supporting legal documents, if required, in the case of estates, trusts, guardianships, custodianships, corporations, partnerships, pension or profit sharing plans, or other organizations. General Information. Your redemption request becomes effective when it is received in proper form by the Funds' Transfer Agent prior to 4:00 P.M. New York time for BAEF and BTMMF and prior to 4:15 P.M., New York time, for the other Funds or your redemption will occur on the following business day. We will make payment for redeemed shares within seven days after receipt by the Transfer Agent. However, we may delay the forwarding of redemption proceeds on shares which were recently purchased until the purchase check has cleared, which may take up to 15 days or more. We may suspend the right of redemption when the New York Stock Exchange is closed or when trading on the Exchange is restricted, and under certain extraordinary circumstances in accordance with the rules of the SEC. Due to the relatively high cost of handling small investments, we reserve the right upon 60 days' written notice to redeem, at net asset value, the shares of any shareholder whose account has a value of less than $1,000, other than as a result of a decline in the net asset value per share. We do not presently contemplate making such involuntary redemptions and will not redeem any shares held in tax-sheltered retirement plans in this category. We also reserve the right upon notice to shareholders to charge a fee for any services provided herein that are currently free of charge. DISTRIBUTION OF SHARES OF THE FUNDS Federated Securities Corp. is the principal distributor for shares of the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Securities Corp. is a subsidiary of Federated Investors. Distribution Plan. According to the provisions of a distribution plan adopted pursuant to Investment Company Act Rule 12b-1, the distributor may select brokers and dealers to provide distribution and administrative services as to shares of the Funds. The distributor may also select administrators (including financial institutions, fiduciaries, custodians for public funds and investment advisers) to provide administrative services. Administrative services may include, but are not limited to, the following functions: 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 shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as each Fund reasonably requests for its shares. Brokers, dealers, and administrators will receive fees based upon shares owned by their clients or customers. The schedules of such fees and the basis upon which such fees will be paid will be determined 37 from time to time by the Boards, provided that for any period the total amount of fees representing an expense to the Trust or the Company shall not exceed an annual rate of .25 of 1% of the average daily net assets of shares of BSTGIF, BFIF, BSTBF and BFTFBF; .50 of 1% of the average daily net assets of shares of BGIF, BCGF, BWEMF and BAEF; and .75 of 1% of the average daily net assets of shares of BGGF and BPMF held in the accounts during the period for which the brokers, dealers, and administrators provide services. Any fees paid by the distributor with respect to shares of a Fund pursuant to the distribution plan will be reimbursed by the Trust or the Company from the assets of the shares of that Fund. The distributor will, periodically, uniformly offer to pay cash or promotional incentives in the form of trips to sales seminars at luxury resorts, tickets or other items to all dealers selling shares of the Funds. Such payments will be predicated upon the amount of shares of the Funds that are sold by the dealer. Such payments, if made, will be in addition to amounts paid under the distribution plan and will not be an expense of a Fund. Administrative Arrangements. The distributor may pay financial institutions a fee based upon the average net asset value of shares of their customers invested in the Funds for providing administrative services. This fee, if paid, will be reimbursed by VCM and not the Funds. Glass-Steagall Act. The Glass-Steagall Act prohibits a depository institution (such as a commercial bank or a savings and loan association) from being an underwriter or distributor of most securities. In the event the Glass-Steagall Act is deemed to prohibit depository institutions from acting in the administrative capacities described above or should Congress relax current restrictions on depository institutions, the Boards will consider appropriate changes in the administrative services. 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. Administrative Services. Federated Administrative Services, a subsidiary of Federated Investors, provides the Funds with certain administrative personnel and services necessary to operate each Fund. Such services include shareholder servicing and certain legal and accounting services. Federated Administrative Services provides these at an annual rate as specified below: Maximum Average Aggregate Daily Net Administrative Fee Assets of the Trust/Corporation ------------------ ------------------------------- .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 The administrative fee received during any fiscal year shall be at least $75,000 per Fund. Federated Administrative Services may voluntarily waive a portion of its fee. Brokerage Transactions. Subject to the supervision of the Board Members and VCM, decisions to buy and sell specific securities for a Fund are made by its Portfolio Adviser. The Portfolio Advisers are authorized, subject to most favorable price and execution, to place portfolio transactions with brokerage firms that provide assistance in the distribution of Fund shares and/or supply research. The Board Members have also authorized the Funds to allocate brokerage to the Portfolio Advisers or an affiliated broker-dealer as well as to use the Distributor, on an agency basis, or affiliates thereof, to effect portfolio transactions 38 which are executed on United States and foreign stock exchanges or which are traded in the over-the-counter market. The Funds have adopted certain procedures incorporating the standards of Rule 17e-1 of the 1940 Act, which require that the commissions paid to a Portfolio Adviser or the Distributor or to affiliated broker-dealers must be "reasonable and fair compared to the commission, fee, or other remuneration received, or to be received, by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." From time to time, a Fund may purchase portfolio securities directly from dealers acting as principals, underwriters or market makers. As these transactions are usually conducted on a net basis, no brokerage commissions are paid by that Fund. Transactions are allocated to various dealers selected by VCM or the Portfolio Advisers primarily on the basis of prompt execution of orders at the most favorable prices. Transactions may be allocated based on the sale of Fund shares. The Funds have determined that the foregoing arrangements are in the best interest of the Funds' shareholders. See "Portfolio Transactions" in each Fund's Statement of Additional Information for further information. TAX MATTERS Each Fund intends to qualify as a regulated investment company by satisfying the requirements under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"), including the requirements with respect to diversification of assets, distribution of income and sources of income. It is each Fund's policy to distribute to its shareholders all of their investment income (net of expenses) and any capital gains (net of capital losses) in accordance with the timing requirements imposed by the Code, so that each Fund will satisfy the distribution requirement of Subchapter M and not be subject to Federal income taxes or the 4% excise tax. If a Fund fails to satisfy any of the Code requirements for qualification as a regulated investment company, it will be taxed at regular corporate tax rates on all of its taxable income (including any capital gains) without any deduction for distributions to shareholders, and distributions to you will be taxable as ordinary dividends (even if derived from the Fund's net long-term capital gains) to the extent of the Fund's current and accumulated earnings and profits. Distributions by a Fund of the excess, if any, of its net long-term capital gain over its net short-term capital loss that are designated as capital gain dividends are taxable to shareholders as long-term capital gains, regardless of the length of time a shareholder has held his shares. The Blanchard 100% Treasury Money Market Fund will be managed in a way so that it will not have any long-term capital gains or losses. Distributions by a Fund of its net investment income and the excess, if any, of its net short-term capital gain over its net long-term capital loss are taxable to shareholders as ordinary income. Depending on a Fund's investments, part or all of such ordinary income dividends could be treated as: (1) dividends attributable to interest from obligations of the United States Government ("U.S. Government Interest Dividends") that would be exempt from state and local taxes; (2) dividends attributable to qualifying dividends ("Qualifying Dividends") that for corporate shareholders would qualify for the 70% dividends-received deduction; or (3) dividends attributable to municipal obligations that would be excluded from regular federal tax and partially exempt from state and local tax ("Exempt Interest Dividends"). A portion of such dividends from the Blanchard Precious Metals Fund, Blanchard Global Growth Fund, and Blanchard American Equity Fund may be Qualifying Dividends. However, this portion cannot exceed the aggregate amount of Qualifying Dividends from domestic corporations received by such Funds during the year, and substantially less than 100% of the ordinary income dividends paid by such Funds may qualify for the deduction. Distributions by the Blanchard Flexible Tax-Free Bond Fund of its tax-exempt interest income (net of expenses) that are designated as Exempt Interest Dividends should be excluded from gross income for federal income tax purposes. However, you are required to report the receipt of Exempt Interest Dividends, together with other tax-exempt interest, on your federal income tax return. In addition, Exempt Interest Dividends may be subject to the federal alternative minimum tax and to state and local income tax, and will 39 be taken into account in determining the portion, if any, of Social Security benefits received which must be included in gross income for federal income tax purposes. Distributions by the Blanchard 100% Treasury Money Market Fund are U.S. Government Interest Dividends. The laws of most states exempt from personal income taxes U.S. Government Interest Dividends from the Fund, which are attributable to interest on United States Treasury obligations. The Fund will advise you each year of the percentage of the Fund's ordinary income dividends which are attributable to U.S. Government Interest Dividends. Investment income that may be received by the Blanchard Short-Term Global Income Fund, Blanchard Short-Term Bond Fund, Blanchard Precious Metals Fund, Blanchard Global Growth Fund, Blanchard Flexible Income Fund, and Blanchard Worldwide Emerging Markets Fund 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 which entitle such Funds to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of a Fund's total assets to be invested in various countries is not known. If more than 50% of the value of a Fund's total assets at the close of its taxable year consist of stock or securities of foreign corporations, such Fund may elect to "pass through" to its shareholders the amount of foreign taxes paid by the Fund. If the Fund so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the Fund, and would be treated as having paid his pro rata share of such foreign taxes and therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax. Distributions to you will be treated in the same manner for federal income tax purposes whether you elect to receive them in cash or reinvest them in additional shares. In general, you take distributions into account in the year in which they are made. However, you are required to treat certain distributions made during January as having been paid by a Fund and received by you on December 31 of the preceding year. A statement setting forth the federal income tax status (i.e., U.S. Government Interest Dividends, Qualifying Dividends, Exempt Interest Dividends, or net capital gain dividends) of all distributions made (or deemed made) during the year will be sent to you promptly after the end of each year. If you purchase shares of a Fund just prior to the record date, you will be taxed on the entire amount of the dividend received, even though the net asset value per share on the date of such purchase may have reflected the amount of such dividend. Upon the sale or redemption of shares of a Fund, you will recognize gain or loss in an amount equal to the difference between the proceeds of the sale or redemption and your adjusted tax basis in the shares. Any loss realized upon a taxable disposition of shares within six months from the date of their purchase will be disallowed to the extent of any exempt-interest dividends received on the shares and, to the extent not disallowed, will be treated as long-term capital loss to the extent of any capital gain dividends received on such shares. All or a portion of any loss realized upon a taxable disposition of shares of a Fund may be disallowed if other shares of the Fund are purchased within thirty days before or after such disposition. If you are a non-resident alien or foreign entity shareholder, ordinary income dividends paid to you generally will be subject to United States withholding at a rate of 30% (or a lower rate under an applicable treaty). If you are a non-United States shareholder, we urge you to consult your own tax advisor concerning the applicability of United States withholding tax. Under the back-up withholding rules of the Code, you may be subject to 31% withholding of federal income tax on ordinary income dividends, capital gain dividends, and redemption payments made by the 40 Funds. In order to avoid this back-up withholding, you must provide the Fund with a correct taxpayer identification number (which, if you are an individual, is usually your Social Security number), and certify that you are a corporation or otherwise exempt from or not subject to back-up withholding. The foregoing discussion of federal income tax consequences is based on tax laws and regulations in effect on the date of this Prospectus, and is subject to change by legislative or administrative action. As the foregoing discussion is for general information only, you should also review the more detailed discussion of federal income tax considerations relevant to the Funds that is contained in the Funds' Statement of Additional Information. In addition, you should consult with your own tax advisor as to the tax consequences of investments in the Funds. PERFORMANCE INFORMATION Advertisements and communications to investors regarding the Funds may cite certain performance and ranking information and may make performance comparisons to other Funds or to relevant indices, as described below. In addition, the Funds' Portfolio Advisers and other outside analysts may, from time to time, report on the market outlook for their investments as well as comment on the historical reasons for these investments including as a hedge against inflation. The Funds' performance may be calculated both in terms of total return and on the basis of current yield over any period of time and may include a computation of a Fund's distribution rate. Total Return. Cumulative total return data is computed by considering all elements of return, including reinvestment of dividends and capital gains distribution, over a stated period of time. Cumulative total return figures are not annualized and represent the aggregate percentage or dollar value change over the period in question. Average annual return will be quoted for at least the one, five and ten year periods ending on a recent calendar quarter (or if such periods have not yet elapsed, at the end of a shorter period corresponding to the life of a Fund for performance purposes). Average annual total return figures are annualized and, therefore, represent the average annual percentage change over the period in question. Yield Information. The term "yield" refers to the income generated by an investment over a one-month or 30-day period. This income is computed by dividing the net investment income per share earned during such period by the maximum public offering price per share on the last day of the period, and then annualizing such 30-day (or one month) yield in accordance with a formula prescribed by the SEC which provides for compounding on a semi-annual basis. The Funds may also quote tax-equivalent yield, which shows the taxable yield that an investor would have to earn before taxes to equal a Fund's tax-free yield. The tax-equivalent yield is calculated by dividing a Fund's tax-exempt yield by the result of one minus any combination of the stated federal, state, or city tax rate. If only a portion of a Fund's income is tax-exempt, only that portion is adjusted in the calculation. Distribution Rate. The Funds may also quote distribution rates and/or effective distribution rates in sales literature or other shareholders communications. A Fund's distribution rate is computed by dividing the most recent monthly distribution per share annualized by dividing the distribution rate by the ratio used to annualize the distribution and reinvesting the resulting amount for a full year on the basis of such ratio. The effective distribution rate will be higher than the distribution rate because of the compounding effect of the assumed reinvestment. A Fund's distribution rate may differ from its yield because the distribution rate may contain net investment income and other items of income (such as returns of capital), while yield reflects only earned interest and dividend items of income. Comparative Results. From time to time in advertisements or sales material, a Fund may discuss its performance rating and may be compared to the performance of other mutual funds or mutual fund indexes 41 as published by widely recognized independent mutual fund reporting services such as Lipper Analytical Services, Inc., CDA and Morningstar, Inc. A Fund may also discuss the past performance and ranking of its Portfolio Adviser, and compare its performance to various investment indexes. The Funds may use performance information as reported in publications of general interest, national, financial and industry publications such as Forbes or Money Magazine and various investment newsletters such as Donoghue's Money Letter. In addition, the Funds may compare their total return to the total return of indexes of U.S. markets or world markets, to that of other mutual funds, individual country indexes, or other recognized indexes. From time to time, the Funds may provide information on certain markets or countries and specific equity securities and quote published editorial comments and/or information from newspapers, magazines, investment newsletters and other publications such as The Wall Street Journal, Money Magazine, Forbes, Barron's, USA Today and Mutual Fund Investors. We may also compare the historical returns on various investments, performance indexes of those investments or economic indicators. In addition, the Funds may reprint articles about a Fund and provide them to prospective shareholders. The Distributor may also make available economic, financial and investment reports to shareholders and prospective shareholders. In order to describe these reports, the Funds may include descriptive information on the reports in advertising literature sent to the public prior to the mailing of a prospectus. Performance information may be quoted numerically or may be presented in a table, graph, chart or other illustration. It should be noted that such performance ratings and comparisons may be made with funds which may have different investment restrictions, objectives, policies or techniques than the Funds, and that such other funds or market indicators may be comprised of securities that differ significantly from the Funds' investments. Performance information will vary from time to time and past results are not necessarily representative of future results. You should remember that a Fund's performance is a function of portfolio management in selecting the type and quality of securities in which a Fund may invest, and is affected by operating, distribution and marketing expenses. ADDITIONAL INFORMATION ABOUT THE FUNDS Blanchard Funds Blanchard Funds (the "Trust"), is a Massachusetts business trust organized on January 24, 1986 which currently consists of ten series. All of the series are non-diversified series of the Trust other than BTMMF which is diversified. Under Massachusetts law, the Trust and its series are generally not required to hold annual or special shareholder meetings. However, special meetings of shareholders may be held for such purposes as electing trustees, changing fundamental policies, approving an investment management/advisory agreement or approving a distribution and marketing plan, if any, and, at the request of the shareholders, to replace trustees. Shareholders holding 10% or more of the Trust's outstanding shares may call a special meeting of shareholders. Shareholders may remove trustees from office whenever not less than two-thirds of the outstanding shares either present a written declaration to the Transfer Agent or vote at a meeting called for this purpose. In certain circumstances, shareholders shall be given access to a list of the names and addresses of all other shareholders, the number of shareholders and the cost of mailing a request to them. Blanchard Precious Metals Fund, Inc. BPMF is a non-diversified investment company organized as a Maryland corporation on June 1, 1987. As such, no annual or special meetings of Fund shareholders will be held except as may be required by the Maryland General Corporation Law or the 1940 Act, or as the Board of Directors of the Fund may determine. 42 A director of the Fund generally may be removed by the holders of not less than a majority of the Fund's outstanding shares. In addition, the directors of the Fund will promptly call a meeting of shareholders for any purpose or purposes, including to vote on whether to remove any director(s) when requested to do so in writing by record holders of not less than 10% of the outstanding shares of the Fund. Finally, in certain circumstances, shareholders shall be given access to a list of the names and addresses of all other shareholders or be informed by the Fund of the number of shareholders and the cost of mailing their request. All Funds Shares of each series of the Trust represent shares of beneficial interest. Shares of BPMF represent shares of common stock. Each share has equal rights with respect to voting matters of that series or of BPMF. In the event of dissolution or liquidation of a series or of BPMF, holders of shares will receive pro rata, subject to the rights of creditors, the proceeds of the sale of the assets less its liabilities. There are no preemptive or conversion rights applicable to the shares of a Fund. Shares of a Fund, when issued, will be fully paid, non-assessable and transferable. The Board Members may create additional series of shares without shareholder approval. BPMF and each series of the Trust is individually responsible only for its own expenses and operating costs and incurs no liability with respect to the expenses and costs of any other series or for BPMF, other than those which affect the Blanchard Group Funds as a group and are allocated among the series and/or BPMF based upon their relative average net assets during the year. There is a remote possibility that one Fund might become liable for any misstatement in the Prospectus about another Fund. This Prospectus omits certain information contained in the registration statement as filed with the SEC. Copies of the registration statement, including items omitted herein, may be obtained from the SEC by paying the charges prescribed under its rules and regulations. Each Fund's Statement of Additional Information included in this registration statement may be obtained without charge from your Fund. No person has been authorized to give any information or to make any representations other than those contained in this Prospectus and in the Statements of Additional Information, and information or representations not herein contained, if given or made, must not be relied upon as having been authorized by a Fund. This Prospectus does not constitute an offer or solicitation in any jurisdiction in which such offering may not lawfully be made. The Code of Ethics of the Investment Adviser and the Funds prohibits all affiliated personnel from engaging in personal investment activities which compete with or attempt to take advantage of the Funds' planned portfolio transactions. The objective of the Code of Ethics of both the Funds and Investment Adviser is that their operations be carried out for the exclusive benefit of the Funds' shareholders. Both organizations maintain careful monitoring of compliance with the Code of Ethics. Independent Accountants. Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York 10036, has been appointed the independent accountants for the Funds. Custodian, Transfer Agent and Dividend Disbursing Agent. United States Trust Company of New York, 770 Broadway, New York, New York 10003, is the Funds' Custodian, Transfer Agent and Dividend Disbursing Agent. Shareholder Inquiries. Shareholder inquiries concerning the status of an account or information concerning the Funds should be directed to Signet Financial Services, Inc. at 41 Madison Avenue, 24th Floor, New York, New YOrk 10010, or calling 1-800-829-3863. 43 ADDITIONAL INVESTMENT INFORMATION Municipal Obligations (BFTFBF) The two principal classifications of Municipal Obligations which may be held by the Fund are "general obligation" securities and "revenue" securities. General obligation securities are secured by the issuer's pledge of its full faith, credit, and taxing power for the payment of principal and interest. Revenue securities are payable only from the revenues derived from a particular facility or class of facilities, or in some cases, from the proceeds of a special excise tax or other specific revenue source such as the user of the facility being financed. Private activity bonds held by the Fund are in most cases revenues currencies and are not payable from the unrestricted revenues of the issuer. Consequently, the credit quality of private activity revenue bonds is usually directly related to the credit standing of the corporate user of the facility involved. The Fund's portfolio may also include "moral obligation" securities, which are normally issued by special-purpose public authorities. If the issuer of moral obligation securities is unable to meet its debt service obligation from current revenues, it may draw on a reserve fund the restoration of which is a moral commitment, but not a legal obligation of the state or municipality which created the issuer. There is no limitation on the amount of moral obligation securities that may be held by the Fund. The Fund may also purchase custodial receipts evidencing the right to receive either the principal amount or the periodic interest payments or both with respect to specific underlying Municipal Obligations ("Stripped Municipal Obligations"). In a typical custodial receipt arrangement, an issuer or a third party owner of Municipal Obligation deposits such obligations with a custodian in exchange for two classes of custodial receipts. The two classes have different characteristics, but, in each case, payments on the two classes are based on payments received on the underlying Municipal Obligations. One class has the characteristics of a typical auction mechanism. This class' interest rate generally is expected to be below the coupon rate of the underlying Municipal Obligations and interest rate adjustments. The second class bears interest at a rate that exceeds the interest rate typically borne by a security of comparable quality and maturity; this rate also is adjusted, but in this case inversely to changes in the rate of interest of the first class. If the interest rate on the first class exceeds the coupon rate of the underlying Municipal Obligations, its interest rate will exceed the rate paid on the second class. In no event will the aggregate interest paid with respect to the two classes exceed the interest paid by the underlying Municipal Obligations. The value of the second class and similar securities should be expected to fluctuate more than the value of a Municipal Obligation of comparable quality and maturity and their purchase by the Fund should increase the volatility of its net assets value and, thus, its price per share. These custodial receipts are sold in private placements.The Fund also may purchase directly from issuers, and not in a private placement, Municipal Obligations having the same characteristics as the custodial receipts. The Fund intends to purchase Stripped Municipal Obligations only when the yield thereon will be exempt from Federal income tax to the same extent as interest on the underlying Municipal Obligations. Stripped Municipal Obligations are considered illiquid securities subject to the 10% limit described in "Investment Limitations" in the Statement of Additional Information. The Fund may purchase and sell municipal bond index and interest rate future contracts as a hedge against changes in market condition. See "Risks" below. U.S. Government Securities (BSTBF, BFIF, BAEF) The term "U.S. Government Securities" refers to debt securities denominated in U.S. dollars issued or guaranteed by the U.S. Government, by various of its agencies, or by various instrumentalities established or sponsored by the U.S. Government. Certain of these obligations including U.S. Treasury bills, notes and bonds, mortgage participation certificates guaranteed by the Government National Mortgage Association ("GNMA") and Federal Housing Administration debentures, are supported by the full faith and credit of the 44 United States. Other U.S. Government Securities issued or guaranteed by Federal agencies or government sponsored enterprises are not supported by the full faith and credit of the United States. These securities include obligations supported by the right of the issuer to borrow from the U.S. Treasury, such as obligations of Federal Home Loan Banks, and obligations supported only by the credit of the instrumentality, such as Federal National Mortgage Association bonds. When purchasing securities in the U.S. Government market, the Portfolio Advisers may take full advantage of the entire range of maturities of U.S. Government Securities and may adjust the average maturity of the investments held in the portfolio from time to time, depending on its assessment of relative yields of securities of different maturities and its expectations of future changes in interest rates. To the extent that a Fund invests in the mortgage market, the Portfolio Advisers usually will evaluate, among other things, relevant economic, environmental and security-specific variables such as housing starts, coupon and age trends. To determine relative value among markets the Portfolio Advisers may use tools such as yield/duration curves, break-even prepayment rate analysis and holding-period-return scenario testing. A Fund may seek to increase its current income by writing covered call or put options with respect to some or all of the U.S. Government Securities held in its portfolio. In addition, a Fund may at times, through the writing and purchase of options on U.S. Government Securities, and the purchase and sale of futures contracts and related options with respect to U.S. Government Securities, seek to reduce fluctuations in net asset value by hedging against a decline in the value of U.S. Government Securities owned by that Fund or an increase in the price of such securities which such Fund plans to purchase, although it is not the general practice to do so. Significant option writing opportunities generally exist only with respect to longer term U.S. Government Securities. Options on U.S. Government Securities and futures and related options are not considered U.S. Government Securities; accordingly, they have a different set of risks and features. These practices and related risks are described in each Fund's Statement of Additional Information. U.S. Government Securities are considered among the most creditworthy of fixed income investments. Because of this added safety, the yields available from U.S. Government Securities are generally lower than the yields available from corporate debt securities. The value of U.S. Government Securities (like those of fixed income securities generally) will change as interest rates fluctuate. During periods of failing U.S. interest rates, the values of outstanding long term U.S. Government Securities generally rise. Conversely, during periods of rising interest rates, the values of such securities generally decline. The magnitude of these fluctuations will generally be greater for securities with longer maturities and the Funds expect that their portfolios of U.S. Government securities will be weighted towards the longer maturities at least to the extent that they have written call options thereon. Although changes in the value of U.S. Government Securities will not affect investment income from those securities, they will affect a Fund's net asset value. Investment Grade Fixed Income Securities (BSTBF, BFIF) The Funds may invest in investment grade U.S. fixed income securities. Such investments may include mortgage related securities that are not U.S. Government Securities, asset backed securities and fixed income securities rated Baa or higher by Moody's or BBB by Standard & Poor's. Fixed income securities rated Baa by Moody's or BBB by Standard & Poor's are considered investment grade obligations which lack outstanding investment characteristics and may have speculative characteristics as well. See Appendix A for the descriptions of these rating categories. Mortgage Related Securities. Mortgage related securities issued by financial institutions (or separate trusts or affiliates of such institutions), even where backed by U.S. Government securities, are not considered U.S. Government Securities. The mortgage pass-through market is marked by high liquidity and credit quality. The primary risk that exists for mortgage pass-through securities is interest rate risk. Changes 45 in market yields will affect the value of these securities as the price of fixed income securities generally increases when interest rates decline and decreases when interest rates rise. Prices of longer term securities generally increase or decrease more sharply than those of shorter term securities in response to interest rate changes. In addition, prepayment of principal on mortgage pass-through securities may make it difficult to lock in interest rates for a fixed period of time. To the extent that mortgage securities are purchased at prices that differ from par, these prepayments (which are received at par) may make up a significant portion of the pass-through total return. Generally, mortgage securities yield more than Treasury securities of the same average life. For more information on mortgage-related securities, see "Investment Objective and Policies" in each Fund's Statement of Additional Information. Asset-Backed Securities. In general, asset-backed securities in which a Fund may invest are issued as debt securities by special purpose corporations. These securities represent an undivided ownership interest in a pool of installment sales contracts and installment loans collateralized by, among other things, credit card receivables and automobiles. The Funds will invest in, to the extent available, (i) loan pass-through certificates or participations representing an undivided ownership interest in pools of installment sales contracts and installment loans (the "Participations") and (ii) debt obligations issued by special purpose corporations which hold subordinated equity interests in such installment sales contracts and installment loans. The Funds anticipate that a substantial portion of the asset-backed securities in which they invest will consist of the debt obligations of such special purpose corporations. Asset-backed securities, in general, are of a shorter maturity (usually five years) than most conventional mortgage-backed securities and historically have been less likely to experience substantial prepayments. Furthermore, the effect of prepayments on securities that have shorter maturities, such as asset-backed securities,is much smaller than the effect of prepayments on securities having longer maturities, such as mortgage-backed securities. The yield characteristics of asset-backed securities differ from more traditional debt securities in that interest and principal payments are paid more frequently, usually monthly, and principal may be prepaid at any time. As a result, if a Fund purchases an asset-backed security at a discount, similar to conventional mortgage-backed securities, a prepayment rate that is faster than expected will increase yield to maturity, while a prepayment rate that is slower than expected will reduce yield to maturity. Conversely, if a Fund purchases an asset-backed security at a premium, faster than expected prepayments will reduce, while slower than expected prepayments will increase, yield to maturity. Prepayments may result from a number of factors, including trade-ins and liquidations due to default, as well as the receipt of proceeds from physical damage, credit, life and disability insurance policies. The rate of prepayments on asset-backed securities may also be influenced by a variety of economic and social factors, including general measures of consumer confidence; accordingly, from time to time, substantial amounts of prepayment may be available for reinvestment by a Fund and will be subject to the prevailing interest rates at the time of prepayment. Asset-backed securities often contain elements of credit support to lessen the effect of the potential failure by obligors to make timely payments on underlying assets. Credit support falls into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by an obligor on the underlying asset. Liquidity protection ensures that the pass through of payments due on the installment sales contracts and installments on loans which comprise the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default enhances the likelihood of ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance polices or letters of credit obtained by the issuer or sponsor from third parties; through various means of structuring the transaction, or through a combination of such approaches. The Funds will not pay any additional fees for such credit support. However, the existence of credit support may 46 increase the market price of the security. For more information on asset-backed securities, see "Investment Objective and Policies" in each Fund's Statement of Additional Information. High Yield Securities (BSTBF, BSTGIF, BFIF) Lower rated fixed income securities, including debt securities, convertible securities and preferred stock and unrated corporate fixed income securities, commonly referred to as "junk bonds," are considered speculative and involve greater risk of default or price changes due to changes in the issuer's creditworthiness than higher rated fixed income securities. Convertible securities are bonds, debentures, notes, preferred stock or other securities which may be converted or exchanged by the holder into shares of the underlying common stock at a stated exchange ratio. A convertible security may also be subject to redemption by the issuer but only after a date and under certain circumstances (including a specified price) established on issue. Adjustable rate preferred stocks are preferred stocks which adjust their dividend rates quarterly based on specified relationships to certain indexes of U.S. Treasury Securities. A Fund may continue to hold securities obtained as a result of the conversion of convertible securities held by such Fund when the Portfolio Adviser believes retaining such securities is consistent with the Fund's investment objective. Differing yields on fixed income securities of the same maturity are a function of several factors, including the relative financial strength of the issuers. Higher yields are generally available from securities in the lower categories of recognized rating agencies, i.e., Ba or lower by Moody's or BB or lower by Standard & Poor's. A Fund may invest in any security which is rated by Moody's or Standard & Poor's, or in any unrated security which the Portfolio Advisers determine is of suitable quality. Securities in the rating categories below Baa as determined by Moody's and BBB as determined by Standard & Poor's are considered to be of poor standing and predominantly speculative. The rating services descriptions of these rating categories, including the speculative characteristic of the lower categories, are set forth in Appendix A. Securities ratings are based largely on the issuer's historical financial information and the rating agencies' investment analysis at the time of rating. Consequently, the rating assigned to any particular security is not necessarily a reflection of the issuer's current financial condition, which may be better or worse than the rating would indicate. Although the Funds' Portfolio Advisers will consider security ratings when making investment decisions in the High Yield Market, they will perform their own investment analysis and will not rely principally on the ratings assigned by the rating services. A Portfolio Adviser's analysis generally may include, among other things, consideration of the issuer's experience and managerial strength, changing financial condition, borrowing requirements or debt maturity schedules, and its responsiveness to changes in business conditions and interest rates. It also considers relative values based on anticipated cash flow, interest or dividend coverage, asset and earnings prospects. The Blanchard Short-Term Global Income Fund ("BSTGIF") may invest in collateralized mortgage obligations ("CMOs"). Collateralized mortgage obligations are debt obligations collateralized either by mortgage loans or mortgage pass-through securities (such collateral collectively being called "Mortgage Assets"). Payments of principal and interest on the Mortgage Assets and any reinvestment income thereon provide the funds to pay debt service on the CMOs. CMOs may be issued by the U.S. Government, its agencies or instrumentalities or by private originators of or investors in mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment bankers and special purpose subsidiaries of such entities. Typically, CMOs are collateralized by GNMA certificates or other government mortgage-backed securities, but they may also be collateralized by whole loans or private mortgage pass-through securities. In a CMO, a series of bonds or certificates is issued in multiple classes. Each class of CMOs, also referred to as a "tranche," is issued at a specific fixed or floating coupon rate and has a stated maturity or 47 final distribution date. Principal prepayments on the Mortgage Assets may cause the CMOs to be retired substantially earlier than their stated maturities or final distribution date. Interest is paid or accrues on all classes of the CMOs (other than any "principal-only" class) on a monthly, quarterly or semi-annual basis. The principal and interest on the Mortgage Assets may be allocated among the several classes of a CMO in many ways. In a common structure, payments of principal (including any prepayments) on the Mortgage Assets are applied to the classes of the series of a CMO in the order of their respective stated maturities or final distribution dates, so that no payment of principal will be made on any class of CMO until all other classes having an earlier stated maturity or final distribution date have been paid in full. BSTGIF may also invest in stripped mortgage-backed securities ("SMBS"). Stripped mortgage-backed securities are derivative multi-class mortgage securities and may be issued by agencies or instrumentalities of the U.S. Government or by private originators of or investors in mortgage loans, including savings and loan associations, mortgage bankers, commercial banks, investment bankers and special purpose subsidiaries of the foregoing. SMBS are usually structured with two classes that receive different proportions of the interest and/or principal distributions on a pool of Mortgage Assets. A common type of SMBS will have one class receiving some of the interest and most of the principal from the Mortgage Assets, while the other class will receive most of the interest and the remainder of the principal. In the most extreme case, one class will receive all of the interest (the interest-only or "IO" class), while the other class will receive all of the principal (the principal-only or "PO" class). The yields to maturity on both PO and IO classes are extremely sensitive to the rate of principal payments (including prepayments) on the related underlying Mortgage Assets. If the underlying Mortgage Assets of an IO class of SMBS experience greater than anticipated prepayments of principal, an investor may fail to recoup fully its initial investment in these securities even if the securities are rated in the highest rating category. SMBS experience greater volatility in market value than mortgage securities in general. CERTAIN INVESTMENT STRATEGIES AND POLICIES Options and Futures Transactions (BSTBF, BSTGIF, BFIF, BWEMF, BPMF, BGGF) General. The successful use of these investment techniques depends on the ability of Fund management to forecast interest rate and currency exchange rate movements correctly. Should interest or exchange rates move in an unexpected manner, a Fund may not achieve the anticipated benefits of futures contracts, options or forward contracts or may realize losses and thus be in a worse position than if such strategies had not been used. Unlike many exchange-traded futures contracts and options on futures contracts, there are no daily price fluctuation limits with respect to options on currencies and forward contracts, and adverse market movements could therefore continue to an unlimited extent over a period of time. In addition, the correlation between movements in the prices of such instruments and movements in the price of the securities and currencies hedged or used for cover will not be perfect and could produce unanticipated losses. A Fund's ability to dispose of its positions in futures contracts, options and forward contracts will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to a number of fixed income securities and currencies are relatively new and still developing. It is impossible to predict the amount of trading interest that may exist in various types of futures contracts, options and forward contracts. If a secondary market does not exist with respect to an option purchased or written by a Fund over-the-counter, it might not be possible to effect a closing transaction in the option (i.e., dispose of the option) with the result that (i) an option purchased by the Fund would have to be exercised in order for the Fund to realize any profit and (ii) the Fund may not be able to sell currencies or portfolio securities covering an option written by the Fund until the option expires or it delivers the underlying futures 48 contract or currency upon exercise. Therefore, no assurance can be given that the Funds will be able to utilize these instruments effectively for the purposes set forth above. The selection of futures and option strategies requires skills different from those needed to select portfolio securities, however, the Portfolio Advisers do have experience in the use of futures and options. Furthermore, a Fund's ability to engage in options and futures transactions may be limited by tax considerations. See "Tax Matters" in each Fund's Statement of Additional Information. Options on Portfolio Securities. (BSTBF, BSTGIF, BFIF) A Fund, in seeking to generate high current income, may write covered call options on certain of its portfolio securities at such time and from time to time as Fund management shall determine to be appropriate and consistent with the investment objective of the Fund. A covered call option means that the Fund owns the security on which the option is written. Generally, the Funds expect that options written by them will be traded on recognized securities exchanges. In certain instances, however, a Fund may purchase and sell options in the over-the-counter market ("OTC Options"). A Fund's ability to close option positions established in the over-the-counter market may be more limited than in the case of exchange-traded options and may also involve the risk that securities dealers participating in such transactions would fail to meet their obligations to the Fund. In addition, the staff of the SEC has taken the position that OTC Options and the assets used as "cover" should be treated as illiquid securities. There is no fixed limit on the percentage of a Fund's assets upon which options may be written. The Funds will receive a premium (less any commissions) from the writing of such contracts, and it is believed that the total return to the Funds can be increased through such premiums consistent with each Fund's investment objective. The writing of option contracts is a highly specialized activity which involves investment techniques and risks different from those ordinarily associated with investment companies, although the Funds believe that the writing of covered call options listed on an exchange or traded in the over-the-counter market, where the Fund owns the underlying security, tends to reduce such risks. The writer forgoes the opportunity to profit from an increase in market price of the underlying security above the exercise price so long as the option remains open. See each Fund's Statement of Additional Information for more information. Futures Contracts and Options on Futures Contracts. (BSTBF, BFTFBF, BFIF) A Fund may enter into contracts for the purchase or sale for future delivery of interest rate instruments, fixed-income securities, foreign currencies, or contracts based on financial indices including any index of U.S. Government Securities, foreign government securities or corporate debt securities ("futures contracts") and may purchase and write put and call options to buy or sell futures contracts ("options on futures contracts"). A "sale" of a futures contract means the acquisition of a contractual obligation to deliver the securities or foreign currencies called for by the contract at a specified price on a specified date. A "purchase" of a futures contract means the incurring of a contractual obligation to acquire the securities or foreign currencies called for by the contract at a specified price on a specified date. Options on futures contracts to be written or purchased by a Fund will be traded on U.S. or foreign exchanges or over-the-counter. See "Additional Risks of Futures Contracts and Related Options, Forward Foreign Currency Exchange Contracts and Options on Foreign Currencies" below and in each Fund's Statement of Additional Information for further discussion of the use, risks and costs of futures contracts and options on futures contracts. Although most futures contracts call for making or taking delivery of the underlying securities, these obligations are typically cancelled or closed out before the scheduled settlement date. The closing is accomplished by purchasing (or selling) an identical futures contract to offset a short (or long) position. Such an offsetting transaction cancels the contractual obligations established by the original futures transaction. Other financial futures contracts call for cash settlements rather than delivery of securities. 49 If the price of an offsetting futures transaction varies from the price of the original futures transaction, the Funds will realize a gain or loss corresponding to the difference. That gain or loss will tend to offset the unrealized loss or gain on the hedged securities transaction, but may not always or completely do so. In contrast to the purchase or sale of a security, the full purchase price of the futures contract is not paid or received by a Fund upon its purchase or sale. Instead, the Funds will deposit in a segregated custodial account an amount of cash or U.S. Treasury bills equal to approximately 5% of the value of the contract. This amount is known as initial margin. The nature of initial margin in futures transactions is different from that of margin in security transactions in that futures contract margin does not involve the borrowing of Funds by the customer to finance the transactions. Rather, the 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. Subsequent payments to and from the broker, called variation margin, will be made on a daily basis as the price of the underlying security fluctuates making the long and short positions in the futures contract more or less valuable, a process known as "mark to the market." For example, when a Fund has purchased a futures contract and the price of the underlying security has risen, that position will have increased in value and the Fund will receive from the broker a variation margin payment equal to that increase in value. Conversely, where a Fund has purchased a futures contract and the price of the underlying security has declined, the position would be less valuable and the Fund would be required to make a variation margin payment to the broker. At any time prior to expiration of the futures contract, a Fund may elect to terminate the position by taking an opposite position. A final determination of variation margin is then made, additional cash is required to be paid by or released to that Fund, and the Fund realizes a loss or gain. No assurance can be given that the Funds will be able to take an opposite position. The Funds will not (i) enter into any futures contracts or options on futures contracts if immediately thereafter the aggregate of margin deposits on all the outstanding futures contracts of a Fund and premiums paid on outstanding options on futures contracts would exceed 5% of the market value of the total assets of the Fund, or (ii) enter into any futures contracts or options on futures contracts if the aggregate of the market value of the outstanding futures contracts of a Fund and the market value of the currencies and futures contracts subject to outstanding options written by the Fund would exceed 50% of the market value of the total assets of that Fund. Options on Foreign Currencies. (BSTBF, BSTGIF, BFIF) The Funds may purchase and write put and call options on foreign currencies to increase a Fund's gross income and for the purpose of protecting against declines in the U.S. dollar value of foreign currency denominated portfolio securities and against increases in the U.S. dollar cost of such securities to be acquired. As in the case of other kinds of options, however, the writing of an option on a foreign currency constitutes only a partial hedge, up to the amount of the premium received, and the Funds could be required to purchase or sell foreign currencies at disadvantageous exchange rates, thereby incurring losses. The purchase of an option on a foreign currency may constitute an effective hedge against fluctuations in exchange rates although, in the event of rate movements adverse to a Fund's position, it may forfeit the entire amount of the premium plus related transaction costs. Options on foreign currencies to be written or purchased by a Fund are traded on U.S. and foreign exchanges or over-the-counter. There is no specific percentage limitation on a Fund's investments in options on foreign currencies. See each Fund's Statement of Additional Information for further discussion on the use, risks and costs of options on foreign currencies. Forward Foreign Currency Exchange Contracts. (BSTBF, BSTGIF, BFIF, BWEMF) The Funds will purchase or sell forward foreign currency exchange contracts ("forward contracts") as part of their portfolio investment strategy. A forward contract is an obligation to purchase or sell a specific currency for an agreed 50 price at a future date which is individually negotiated and privately traded by currency traders and their customers. A Fund may enter into a forward contract, for example, when it enters into a contract for the purchase or sale of a security denominated in a foreign currency in order to "lock in" the U.S. dollar price of the security ("transaction hedge"). Additionally, for example, when a Fund believes that a foreign currency may suffer a substantial decline against the U.S. dollar, it may enter into a forward sale contract to sell an amount of that foreign currency approximating the value of some or all of the Fund's portfolio securities denominated in such foreign currency, or when a Fund believes that the U.S. dollar may suffer a substantial decline against foreign currency, it may enter into a forward purchase contract to buy that foreign currency for a fixed dollar amount ("position hedge"). In this situation, a Fund may, in the alternative, enter into a forward contract to sell a different foreign currency for a fixed U.S. dollar amount where the Fund believes that the U.S. dollar value of the currency to be sold pursuant to the forward contract will fall whenever there is a decline in the U.S. dollar value of the currency in which portfolio securities of the Fund are denominated ("cross-hedge"). The Funds' custodian will place cash not available for investment or U.S. Government Securities or other high quality debt securities in a separate account of a Fund having a value equal to the aggregate amount of that Fund's commitments under forward contracts entered into with respect to position hedges and crosshedges. If the value of the securities placed in a separate account declines, additional cash or securities will be placed in the account on a daily basis so that the value of the account will equal the amount of the Fund's commitments with respect to such contracts. As an alternative to maintaining all or part of the separate account, a Fund may purchase a call option permitting the Fund to purchase the amount of foreign currency being hedged by a forward sale contract at a price no higher than the forward contract price or a Fund may purchase a put option permitting the Fund to sell the amount of foreign currency subject to a forward purchase contract at a price as high or higher than the forward contract price. Unanticipated changes in currency prices may result in poorer overall performance for a Fund than if it had not entered into such contracts. Pursuant to the sub-advisory agreemehts, the Portfolio Advisers, where permitted by law, will purchase and sell foreign exchange in the interbank dealer market for a fee on behalf of a Fund, subject to certain procedures and reporting requirements adopted by the Board Members. Additional Risks of Futures Contracts and Related Options, Forward Foreign Currency Exchange Contracts and Options on Foreign Currencies. The market prices of futures contracts may be affected by certain factors. First, all participants in the futures market are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the securities and futures markets. Second, from the point of view of speculators, the deposit requirements in the futures market are less onerous than margin requirements in the securities market. Therefore, increased participation by speculators in the futures market may also cause temporary price distortions. In addition, futures contracts in which the Funds may invest may be subject to commodity exchange imposed limitations on fluctuations in futures contract prices during a single day. Such regulations are referred to as "daily price fluctuation limits" or "daily limits." During a single trading day no trades may be executed at prices beyond the daily limit. Once the price of a futures contract has increased or decreased by an amount equal to the daily limit, positions in those futures cannot be taken or liquidated unless both a buyer and seller are willing to effect trades at or within the limit. Daily limits, or regulatory intervention in the commodity markets, could prevent a Fund from promptly liquidating unfavorable positions and adversely affect operations and profitability. Options on foreign currencies and forward foreign currency exchange contracts ("forward contracts") are not traded on contract markets regulated by the Commodity Futures Trading Commission ("CFTC") and are not regulated by the SEC. Rather, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, 51 such as the Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to SEC regulation. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the SEC, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the OCC, thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the Fund to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, futures contracts and related options and forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in a Fund's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Other Investment Policies Repurchase Agreements. The Funds (other than BTMMF and BPMF) may enter into repurchase agreements. Under a repurchase agreement, a Fund acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the Fund to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which that Fund's money is invested. The Funds' repurchase agreements will at all times be fully collateralized in an amount at least equal to the purchase price including accrued interest earned on the underlying securities. The instruments held as collateral are valued daily, and as the value of instruments declines, the Funds will require additional collateral. If the seller defaults and the value of the collateral securing the repurchase agreement declines, a Fund may incur a loss. If such a defaulting seller were to become insolvent and subject to liquidation or reorganization under applicable bankruptcy or other laws, disposition of the underlying securities could involve certain costs or delays pending court action. Finally, it is not certain whether the Funds would be entitled, as against a claim of the seller or its receiver, trustee in bankruptcy or creditors, to retain the underlying securities. Repurchase agreements are considered by the staff of the STE to be loans by a Fund. 52 Lending of Porffolio Securities. (BSTBF, BFTFBF, BSTGIF, BFIF, BAEF) In order to generate additional income, each Fund may lend its porffolio securities in an amount up to 33-1/3% of total Fund assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities not affiliated with Sheffield. The borrower at all times during the loan must maintain cash or cash equivalent collateral or provide to the Fund an irrevocable letter of credit equal in value to at least 100% of the value of the securities loaned. During the time porffolio securities are on loan, the borrower pays the Fund any dividends or interest paid on such securities, and the Fund may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral should the borrower of any loaned securities fail financially. When-lssued and Forward Transactions and Stand-By Commitments. (BFTFBF) The Fund may purchase eligible securities on a "when issued" basis and may purchase or sell securities on a "forward commitment" basis. The Fund does not intend to engage in "when issued" purchases and forward commitments for speculative purposes, but only in furtherance of its investment objective. The Fund will establish a segregated account with its custodian bank in which it will maintain cash or other high quality debt securities determined daily to be equal in value to the commitments for "when-issued" securities. In addition, the Fund may acquire "stand-by commitments" with respect to Municipal Obligations that it holds. Under a "stand-by commitment," a dealer agrees to purchase, at the Fund's option, specified Municipal Obligations at a specified price. The Fund will acquire "stand-by commitments" solely to facilitate porffolio liquidity and does not intend to exercise its rights thereunder for trading purposes. "Stand-by commitments" acquired by the Fund would be valued at zero in determining the Fund's net asset value. Money Market Instruments. (BFTFBF, BWEMF, BPMF, BGGF, BFIF, BSTBF) Money market instruments include, but are not limited to, the following instruments: government securities; commercial paper; bank certificates of deposit and bankers' acceptances; and repurchase agreements related to any of the foregoing. A Fund will only purchase commercial paper if it is rated Prime-1 or Prime-2 by Moody's or A-1 or A-2 by Standard & Poor's or, if not rated, is considered by Fund management to be of equivalent quality. Under a defensive strategy, BSTBF and BFIF may concentrate their investments in securities issued by banks. Such investments may include certificates of deposit, time deposits, bankers' acceptances, and obligations issued by bank holding companies, as well as repurchase agreements entered into with banks. Illiquid Securities. (BSTBF, BSTGIF, BFIF, BAEF, BGGF) The Funds will not invest in illiquid securities if immediately after such investment more than 10% of a Fund's total assets (taken at market value) would be invested in such securities. See each Fund's Statement of Additional Information. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by a Fund over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Securities that have legal or contractual restrictions on resale but have a readily available market are not deemed illiquid for purposes of this limitation. SEC Rule 144A allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act of 1933 applicable to resales of certain securities to qualified institutional buyers. The Porffolio Advisers anticipate that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this relatively new regulation and the development of automated systems for the trading, clearance and settlement of unregistered security foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. 53 The Portfolio Adviser will monitor the liquidity of restricted securities in each Fund's portfolio under the supervision of the Board Members. In reaching liquidity decisions, the Portfolio Advisers will consider, inter alia, the following factors: (1 ) the frequency of trades and quotes for the security; (2) the number of dealers wanting to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). Non-diversification. All of the Funds' portfolios (other than BTMMF) are "non-diversified" which means the Funds are not limited in the proportion of assets that may be invested in the securities of a single issuer. However, each Fund intends to conduct its operations so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, which will relieve the Funds of any liability for Federal income tax to the extent its earnings are distributed to shareholders. See "Tax Matters". To so qualify, among other requirements, each Fund will limit its investments so that, at the close of each fiscal quarter, (i) not more than 25% of the market value of a Fund's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value will be invested in the securities of a single issuer and a Fund will not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the Funds' requirements to maintain diversification for tax purposes, the issuer of a loan participation will be the underlying borrower. In cases where a Fund does not have recourse directly against the borrower, both the borrower and each agent bank and co-lender interposed between the Fund and the borrower will be deemed issuers of the loan participation for tax diversification purposes. A Fund's investments in U.S. Government Securities are not subject to these limitations. Since the Funds may invest in a smaller number of individual issuers than diversified investment companies, an investment in the Funds may, under certain circumstances, present greater risks to an investor than an investment in a diversified company. Porffolio Turnover. The Funds may engage in active short-term trading to benefit from yield disparities among different issues of securities, to seek short-term profits during periods of fluctuating interest rates, or for other reasons. Such trading will increase a Fund's rate of turnover and the possible incidence of short-term capital gain taxable as ordinary income. VCM anticipates that the annual turnover in each Fund will not be in excess of 200%. An annual turnover rate of 200% occurs, for example, when the dollar equivalent of all of the securities in a Fund's portfolio are replaced twice in a period of one year. A high rate of porffolio turnover involves correspondingly greater expenses than a lower rate, including brokerage commissions or dealer mark-ups and other transaction costs on the sale of securities and reinvestment in other securities, which expenses must be borne by that Fund and its shareholders. High portfolio turnover rate also may result in the realization of substantial net short-term capital gains. In order to continue to qualify as a regulated investment company for Federal tax purposes, less than 30% of the annual gross income of a Fund must be derived from the sale of securities held by the Fund for less than three months. See "Tax Matters". Concentration. Under normal circumstances, and as a matter of fundamental policy, BSTGIF will "concentrate" at least 25% of its total assets in debt instruments issued by domestic and foreign companies engaged in the banking industry, including bank holding companies. Such investments may include certificates of deposit, time deposits, bankers' acceptances, and obligations issued by bank holding companies, as well as repurchase agreements entered into with banks (as distinct from non-bank dealers) in accordance with the policies set forth in "Repurchase Agreements". However, when business or financial conditions warrant, the Fund may, for temporary defensive purposes, vary from its policy of investing at least 25% of its total assets in the banking industry. For example, the Fund may reduce its position in debt 54 instruments issued by domestic and foreign banks and bank holding companies and increase its position in U.S. Government Securities or cash equivalents. Due to the Fund's investment policy with respect to investments in the banking industry, the Fund will have greater exposure to the risk factors which are characteristic of such investments. In particular, the value of and investment return on the Fund's shares will be affected by economic or regulatory developments in or related to the banking industry. Sustained increases in interest rates can adversely affect the availability and cost of funds for a bank's lending activities, and a deterioration in general economic conditions could increase the exposure to credit losses. The banking industry is also subject to the effects of the concentration of loan portfolios in particular businesses such as real estate, energy, agriculture or high technology-related companies; concentration of loan portfolios in lesser developed country loans and highly leveraged transaction loans; national and local regulation; and competition within those industries as well as with other types of financial institutions. In addition, the Fund's investments in commercial banks located in several foreign countries are subject to additional risks due to the combination in such banks of commercial banking and diversified securities activities. As discussed above, however, the Fund will seek to minimize its exposure to such risks by investing only in debt securities which are determined to be of high quality. The other Funds do not concentrate their assets in any industry or industries other than for temporary defensive purposes. Borrowing. (BSTGIF, BWEMF) Each Fund may borrow up to one-third of the value of its total assets from banks to increase its holdings of portfolio securities or in order to meet redemption requests. Under the 1940 Act, a Fund is required to maintain continuous asset coverage of 300% with respect to such borrowings and to sell (within three days) sufficient portfolio holdings to restore such coverage if it should decline to less than 300% due to market fluctuations or otherwise, even if such liquidations of the Fund's holdings may be disadvantageous from an investment standpoint. Leveraging by means of borrowing may exaggerate the effect of any increase or decrease in the value of porffolio securities or a Fund's net asset value, and money borrowed will be subject to interest and other costs (which may include commitment fees and/or the cost of maintaining minimum average balances) which may or may not exceed the income received from the securities purchased with borrowed funds. RISK FACTORS AND SPECIAL CONSIDERATIONS Foreign Investments. (BSTBF, BSTGIF, BFIF, BWEMF, BGGF) Foreign investments involve certain risks that are not present in domestic securities. Because the Funds intend to purchase securities denominated in foreign currencies, a change in the value of any such currency against the U.S. dollar will result in a corresponding change in the U.S. dollar value of a Fund's assets and a Fund's income available for distribution. In addition, although a portion of a Fund's investment income may be received or realized in such currencies, the Internal Revenue Code of 1986 (the "Code") requires that each Fund compute and distribute its income in U.S. dollars. Therefore, if the exchange rate of any such currency declines after the Fund's income has been earned and translated into U.S. dollars but before payment, a Fund could be required to liquidate securities to make such distributions. Similarly, if an exchange rate depreciates between the time a Fund incurs expenses in U.S. dollars and the time such expenses are paid, the amount of such currency required to be converted into U.S. dollars in order to pay such expenses in U.S. dollars will be greater than the equivalent amount in any such currency of such expenses at the time they were incurred. Under the Code, changes in an exchange rate which occur between the time a Fund accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time a Fund actually collects such receivables or pays such liabilities will result in foreign exchange gains or losses that increase or decrease distributable taxable net investment income. Similarly, dispositions of certain debt securities (by sale, at maturity or otherwise) at a U.S. dollar amount which is higher or lower than the Fund's 55 original U.S. dollar cost may result in foreign exchange gains or losses, which will increase or decrease distributable taxable net investment income. The values of foreign investments and the investment income derived from them may also be affected unfavorably by changes in currency exchange control regulations. Although the Funds will invest only in securities denominated in foreign currencies that are fully exchangeable into U.S. dollars without legal restriction at the time of investment, there is no assurance that currency controls will not be imposed subsequently. In addition, the values of foreign fixed-income investments will fluctuate in response to changes in U.S. and foreign interest rates. There may be less information publicly available about a foreign issuer than about a U.S. issuer, and foreign issuers are not generally subject to accounting, auditing and financial reporting standards and practices comparable to those in the United States. The securities of some foreign issuers are less liquid and at times more volatile than securities of comparable U.S. issuers. Foreign brokerage commissions, custodial expenses and other fees are also generally higher than for securities traded in the United States. In addition, with respect to certain foreign countries, there is a possibility of expropriation of assets, confiscatory taxation, political or financial instability and diplomatic developments which could adversely affect the value of investments in those countries. The Portfolio Advisers do not expect to invest the Funds' assets in countries where they believe such events are likely to occur. Income received by a Fund from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes. The Portfolio Advisers will attempt to minimize such taxes by timing of transactions and other strategies, but there is no assurance that such efforts will be successful. Any such taxes paid by a Fund will reduce its net income available for distribution to shareholders. Investors should recognize that investing in debt obligations and other fixed-income securities of issuers in emerging countries involves certain special considerations and risk factors, including those set forth below, which are not typically associated with investing in debt obligations and other fixed-income securities of U.S. issuers. Trading volume in emerging country securities markets is substantially less than in the United States. Further, securities of some emerging country issuers are less liquid and more volatile than securities of comparable U.S. issuers. Commissions for trading on emerging country stock exchanges are generally higher than commissions for trading on U.S. exchanges although the Funds will endeavor to achieve the most favorable net results on their portfolio transactions and may, in certain instances, be able to purchase portfolio investments on other stock exchanges where commissions are negotiable. Issuers in emerging countries are not generally subject to uniform accounting, auditing and financial reporting standards, practices and disclosure requirements comparable to those applicable to U.S. issuers. Consequently, there may be less publicly available information about an emerging country issuer than about a U.S. issuer. Further, there is generally less government supervision and regulation of foreign stock exchanges, brokers and listed issuers than in the United States. The Funds may invest in unlisted emerging country debt obligations and other fixed-income securities, including investments in new and early stage issuers, which may involve a high degree of business and financial risk that can result in substantial losses. Because of the absence of any trading market for these investments, a Fund may take longer to liquidate these positions than would be the case for publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized on these sales couId be less than those originally paid by the Fund. Further, issuers whose securities are not 56 publicly traded may not be subject to public disclosure and other investor protection requirements applicable to publicly traded securities. 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 dependent upon 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. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, government regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or the value of a Fund's investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside of the United States. From time to time, BGGF may invest in Eastern Europe as investment opportunities emerge in those markets, if the Sector Manager deems it prudent in light of then existing social, economic and political conditions. Investing in the securities of issuers in Eastern Europe involves certain additional considerations not usually associated with investing in securities of issuers in more developed capital markets, including the following: (i) political and economic considerations, such as greater risks of expropriation and nationalization and less social, political and economic stability; (ii) the small size of the markets for such securities, the low or nonexistent volume of trading, the lack of liquidity and price volatility; (iii) restrictions on investing in issuers or industries deemed sensitive to relevant national interests; and (iv) the absence of developed legal structures governing private and foreign investments and private property. Applicable accounting and financial reporting standards in Eastern Europe may be substantially different from U.S. accounting standards and, in certain Eastern European countries, no reporting standards may exist. Consequently, substantially less information is available to investors in Eastern Europe, and the information that is available may not be conceptually comparable to, or prepared on the same basis as, that available in more developed capital markets, which may make it difficult to assess the financial status of particular companies. Upon the accession to power of Communist regimes approximately 40 years ago, the governments of a number of Eastern European countries expropriated a large amount of property. The claims of many property owners against those governments were never finally settled. There can be no assurance that the Fund's investments in Eastern Europe, if any, would not also be appropriated, nationalized or otherwise confiscated, in which case the Fund would lose its entire investment in the country involved. In addition, any change in the leadership or policies of Eastern European countries may halt the expansion of or reverse the liberalization of foreign investment policies now occurring. Precious Metals and Precious Metals Securities. (BPMF, BGGF) Investment in securities of precious metals mining, exploration and processing companies involves certain risks. Selective investment in such securities, however, may offer a greater return than shares of domestic industrial issuers. The market action of such securities has tended to move against, or independently of, the market trend of industrial securities; therefore, the addition of securities of companies involved in precious metals operations to an investor's porffolio may increase the return and may reduce overall fluctuations in porffolio value. Thus, an investment in a Fund should be considered part of an overall investment program rather than as a complete investment program in itself. 57 Prices of precious metals mining securities can be volatile and tend to experience greater volatility than the prices of physical precious metals. This is due to the fact that the costs of mining precious metals remain relatively fixed, so that an increase or decrease in the price of precious metals has a direct and greater than proportional effect on the profitability of precious metals mining companies. Investments tied to precious metals characteristically involve high risk because of precious metals' price volatility. The price of precious metals is affected by factors such as cyclical economic conditions, political events and monetary policies of various countries (see "Investment Objective and Policies-Additional Information Regarding Precious Metals and Precious Metals Securities" in each Fund's Statement of Additional Information of each Fund for historic price information on gold bullion). During periods of rising precious metals prices, investments in Precious Metals Securities will tend to be emphasized with respect to a Fund. The mining of gold is highly concentrated in a few countries. Currently, the five largest producers of gold are the Republic of South Africa, certain republics of the former Soviet Union, Canada, the United States and Australia. Economic and political conditions prevailing in these countries may have a direct effect on the production and marketing of newly produced gold and sales of central bank gold holdings. At any given time, a substantial portion of the investments of a Fund may be concentrated in one or a few foreign countries. See "Investment Objective and Policies-Additional Information Regarding Precious Metals'and Precious Metals Securities" in each Fund's Statement of Additional Information for further details on this subject. Risk Factors-Lower Rated Fixed Income Securities. (BSTBF, BSTGIF, BFIF, BWEMF) Lower quality fixed income securities generally produce a higher current yield than do fixed income securities of higher ratings. However, these fixed income securities are considered speculative because they involve greater price volatility and risk than do higher rated fixed income securities and yields on these fixed income securities will tend to fluctuate over time. Although the market value of all fixed income securities varies as a result of changes in prevailing interest rates (e.g., when interest rates rise, the market value of fixed income securities can be expected to decline), values of lower rated fixed income securities tend to react differently than the values of higher rated fixed income securities. The prices of lower rated fixed income securities are less sensitive to changes in interest rates than higher rated fixed income securities. Conversely, lower rated fixed income securities also involve a greater risk of default by the issuer in the payment of principal and income and are more sensitive to economic downturns and recessions than higher rated fixed income securities. The financial stress resulting from an economic downturn could have a greater negative effect on the ability of issuers of lower rated fixed income securities to service their principal and interest payments, to meet projected business goals and to obtain additional financing than on more creditworthy issuers. In the event of an issuer's default in payment of principal or interest on such securities, or any other fixed income securities in a Fund's portfolio, the net asset value of that Fund will be negatively affected. Moreover, as the market for lower rated fixed income securities is a relatively new one, a severe economic downturn might increase the number of defaults, thereby adversely affecting the value of all outstanding lower rated fixed income securities and disrupting the market for such securities. Fixed income securities purchased by a Fund as part of an initial underwriting present an additional risk due to their lack of market history. These risks are exacerbated with respect to fixed income securities rated Caa or lower by Moody's or CCC or lower by Standard & Poor's. Unrated fixed income securities generally carry the same risks as do lower rated fixed income securities. Lower quality debt securities are typically traded among a smaller number of broker-dealers rather than in a broad secondary market. Purchasers of lower quality debt securities tend to be institutions, rather than individuals, a factor that further limits the secondary market. To the extent that no established retail secondary market exists, many lower quality debt securities may not be as liquid as Treasury and investment grade bonds. The ability of a Fund to sell lower quality debt securities will be adversely affected to the extent that such securities are thinly traded or illiquid. Moreover, the ability of a Fund to value lower 58 quality debt securities becomes more difficult, and judgment plays a greater role in valuation, as there is less reliable, objective data available with respect to such securities that are thinly traded or illiquid. Unrated debt securities are not necessarily of lower quality than rated debt securities, but they may not be attractive to as many buyers. Because investors may perceive that there are greater risks associated with the lower quality debt securities of the type in which the Funds may invest, the yields and prices of such securities may tend to fluctuate more than those for higher quality debt securities. Changes in perception of issuers' creditworthiness tend to occur more frequently and in a more pronounced manner in the lower quality segments of the debt securities market than do changes in higher quality segments of the debt security market, resulting in greater yield and price volatility. The speculative characteristics of lower rated debt securities are set forth in Appendix A. The Funds' Portfolio Advisers believe that the risks of investing in such high yielding, debt securities may be minimized through careful analysis of prospective issuers, Although the opinions of ratings services such as Moody's and Standard & Poor's are considered in selecting securities in which a Fund may invest, they evaluate the safety of the principal and the interest payments of the security, not their market value risk. Additionally credit rating agencies may experience slight delays in updating ratings to reflect current events. The Porffolio Advisers rely, primarily, on their own credit analysis. This may suggest, however, that the achievement of the Fund's investment objective is more dependent on the Porffolio Adviser's proprietary credit analysis, than is otherwise the case for a Fund that invests exclusively in higher quality debt securities. Once the rating of a porffolio security or the quality determination ascribed by a Porffolio Adviser to an unrated debt security has been downgraded, the Porffolio Adviser will consider all circumstances deemed relevant in determining whether to continue to hold the security. Risk Factors-Mortgage Securities. (BSTGIF) The yield characteristics of the mortgage securities differ from those of traditional debt securities. Among the major differences are that interest and principal payments are made more frequently on mortgage securities, usually monthly, and that principal may be prepaid at any time because the underlying mortgage loans or other assets generally permit prepayment at any time. Evaluating the risks associated with prepayment and determining the rate at which prepayments may occur depends on a number of factors. The rate of prepayment is influenced by a variety of economic geographic, demographic, social and other factors including interest rate levels, changes in housing needs, net equity built by mortgagors in the mortgaged properties, job transfers, and unemployment rates. If BSTGIF purchases these securities at a premium, a prepayment rate that is faster than expected will reduce yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity. Conversely, if BSTGIF purchases these securities at a discount, faster than expected prepayments will increase, while slower than expected prepayments will reduce, yield to maturity. Amounts available for reinvestment are likely to be greater during a period of rising interest rates. Accelerated prepayments on securities purchased by BSTGIF at a premium also impose a risk of loss of principal because the premium may not have been fully amortized at the time the principal is repaid in full. The rate of principal payments on the certificates, the aggregate amount of each interest payment and the yield to maturity on mortgage securities are related to the rate of principal payments on the underlying mortgage loans. Such principal payments may be in the form of scheduled principal payments, prepayments by mortgagors, liquidations due to default, casualty, condemnation and certain events usually set forth in the related pooling and servicing agreement. The rate of prepayment may be influenced by a variety of economic, geographic, social and other factors. In general, however, if interest rates on comparable obligations were to fall below the mortgage rates on the underlying mortgage loans, which may be different from prevailing interest rates, the rate of prepayment would be expected to increase. 59 Conversely, if prevailing rates on comparable obligations were to rise above the mortgage rates on the underlying mortgage loans, the mortgage loans would be expected to prepay at lower rates than if prevailing rates on comparable obligations were to remain at or below the mortgage rates on the underlying mortgage loans. The mortgage securities in which BSTGIF may invest differ from conventional bonds in that principal is paid back over the life of the mortgage securities rather than at maturity. As a result, the holder of the mortgage securities (i.e., BSTGIF) receives monthly scheduled payments of principal and interest, and may receive unscheduled principal payments representing prepayments on the underlying mortgages. When the holder reinvests the payments and any unscheduled prepayments of principal it receives, it may receive a rate of interest which is lower than the rate on the existing mortgage securities. For this reason, mortgage-securities are less effective than other types of U.S. Government securities as a means of "locking in" long-term interest rates. 60 APPENDIX A Description of Moody's Investors Service, Inc.'s Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *Aaa: Bonds which are rated Aaa are judged to be 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 fluctuations of protective elements may be of greater amplitude or there may be other elements present which make the long-term risks appear somewhat larger than in Aaa securities. *A: Bonds which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. *Baa: Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba: Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during other good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C: Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating classification from Aa through B in its bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category, the modifier 2 indicates a mid-range ranking, and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. A-1 Description of Standard & Poor's Corporation's Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *AAA: Debt rated AAA have the highest rating assigned by S&P to a debt obligation. Capacity to pay interest and repay principal is extremely strong. *AA: Debt rated AA have a very strong capacity to pay interest and repay principal and differ from the higher rated issues only in small degree. *A: Debt rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. *BBB: Debt rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds in higher rated categories. BB, B, CCC, CC, C: Debt rated "BB," "B," "CCC," "CC" and "C" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "C" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. BB: Debt rated "BB" has less near-term vulnerability to default than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. The "BB" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BBB-" rating. B: Debt rated "B" has a greater vulnerability to default but currently has the capacity to meet interest payments and principal repayments. Adverse business, financial or economic conditions will likely impair capacity or willingness to pay interest and repay principal. The "B" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BB" or "BB-" rating. CCC: Debt rated "CCC" has a currently identifiable vulnerability to default, and is dependent upon favorable business, financial, and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal. The "C" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "B" or "B-" rating. CC: The rating "CC" is typically applied to debt subordinated to senior debt that is assigned an actual or implied "CCC" rating. C: The rating "C" is typically applied to debt subordinated to senior debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating may be used to cover a situation where a bankruptcy petition has been filed, but debt service payments are continued. C1: The rating "C1" is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in payment default. The "D" rating category is used when interest payments or principal payments are not made on the date due even if the applicable grace period has not expired, unless S&P believes that such payments will be made during such grace period. The "D" rating also will be used upon the filing of a bankruptcy petition if debt service payments are jeopardized. Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. NR: Bonds may lack a S&P rating because no public rating has been requested, because there is insufficient information on which to base a rating, or because S&P does not rate a particular type of obligation as a matter of policy. A-2 ------------------------------- BLANCHARD GROUP OF FUNDS ------------------------------- Blanchard Global Growth Fund Blanchard Precious Metals Fund, Inc. Blanchard 100% Treasury Money Market Fund Blanchard Short-Term Global Income Fund Blanchard American Equity Fund Blanchard Flexible Income Fund Blanchard Short-Term Bond Fund Blanchard Flexible Tax-Free Bond Fund Blanchard Worldwide Emerging Markets Fund Prospectus August 7, 1995 Please read and keep for your file B L A N C H A R D Blanchard Group of Funds Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 1-800-829-3863 ------------------------------- B L A N C H A R D ------------------------------- - ------------------------------------- LOGO ------------------------------------- THE BLANCHARD GROUP OF FUNDS Federated Investors Tower, Pittsburgh, Pennsylvania 15222-3779 Blanchard Funds (the "Trust"), which currently consists of ten investment portfolios, and Blanchard Precious Metals Fund, Inc., which currently consists of one investment portfolio (each portfolio individually referred to as a "Fund" and collectively as the "Funds") are open-end management investment companies, which offer separate investment alternatives for different investor needs. Virtus Capital Management, Inc. is the Funds' overall investment adviser. There is no guarantee that the Funds will achieve their investment objectives. Highlights ................................................................. 3 Fee Table .................................................................. 5 Financial Highlights ....................................................... 6 Investment Objectives and Policies ......................................... 8 Additional Information on Investment Policies, Techniques and Risk Factors . 9 Management of the Funds .................................................... 12 ` rtfolio Advisory Services ................................................ 12 How to Invest .............................................................. 14 Investor Services .......................................................... 15 How to Redeem .............................................................. 17 Distribution of Shares of the Funds ........................................ 18 Tax Matters ................................................................ 20 Performance Computation Information ........................................ 21 Additional Information about the Funds and the Portfolios .................. 22 Other Information .......................................................... 24 ------------ Please read this Prospectus carefully and retain it for future reference. The Funds Statements of Additional Information, dated August 7, 1995, has been filed with the Securities and Exchange Commission (the "SEC") and is incorporated herein by reference. It is available upon request to the Funds at 1-800-723-9512. Investments in the Funds are subject to risk-including possible loss of principal-and will fluctuate in value. Shares of the Funds are not bank deposits or obligations of, or guaranteed or endorsed by, Signet Bank or The Chase Manhattan Bank, N.A. or any of their affiliates and are not insured by, obligations of or otherwise supported by the U.S. Government, the Federal Deposit Insurance Corporation, the Federal Reserve Board or any other agency. ------------ 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. Prospectus dated August 7, 1995 - -------------------------------------------------------------------------------- BLANCHARD GROWTH & INCOME FUND BLANCHARD CAPITAL GROWTH FUND Federated Investors Tower Pittsburgh, Pennsylvania 15222-3779 Blanchard Growth & Income Fund and Blanchard Capital Growth Fund, open-end management investment companies, (individually referred to as a "Fund" and collectively as the "Funds") offer two different investment alternatives for investors' objectives. Blanchard Growth & Income Fund seeks to provide long term capital appreciation and to provide dividend income through a broad portfolio of common stocks. To achieve its investment objectives, the Fund invests 100% of its assets in Growth & Income Portfolio (individually referred to as "Growth & Income Portfolio" and collectively with Capital Growth Portfolio as the "Portfolios"), an open-end management investment company advised by The Chase Manhattan Bank, N.A. (the "Portfolio Adviser"), with investment objectives, policies and restrictions identical to those of the Fund. The Portfolio invests primarily (i.e., at least 80% under normal circumstances) in common stocks of issuers (including foreign issuers) ranging from small to medium to large capitalizations. For the most part, the Portfolio Adviser will pursue a "contrary opinion" investment approach selecting common stocks that are currently out of favor with investors in the stock market. These securities are usually characterized by a relatively low price/earnings ratio (using normalized earnings), a low ratio of market price to book value, or underlying asset values that the Portfolio Adviser believes are not fully reflected in the current market price. Blanchard Capital Growth Fund seeks to provide long term capital growth through a broad portfolio of common stocks. To achieve its investment objective, the Fund invests 100% of its assets in Capital Growth Portfolio (individually referred to as "Capital Growth Portfolio" and collectively with Growth & Income Portfolio as the "Portfolios"), an open-end management investment company advised by the Portfolio Adviser, with investment objectives, policies and restrictions identical to those of the Fund. The Portfolio invests primarily (i.e., at least 80% under normal circumstances) in common stocks of issuers (including foreign issuers) that the Portfolio Adviser believes are likely to benefit from changes or trends brought about by social, economic, demographic and legislative developments considered significant by the Portfolio Adviser. It is expected that the investments will emphasize small and medium-sized companies which the Portfolio Adviser believes have the potential to profit from significant changes or trends of the type described above. Dividend income, if any, is a consideration incidental to obtaining the Fund's objective of growth of capital. The performance of the Funds depends on the performance of the Portfolios. The Fund and Portfolio structure is different from that of many other investment companies which directly acquire and manage their own portfolios of securities. For more information on this unique structure, see "Additional Information About the Funds and the Portfolios" on Page 21. There can be no guarantee that the Funds and the Portfolios will achieve their investment objectives. Virtus Capital Management, Inc. ("VCM") is the Funds' investment adviser. 2 HIGHLIGHTS The Funds' Objectives. The Funds, which are open-end management investment companies, invest in the Portfolios which, in turn, invest in securities in accordance with investment objectives, policies and restrictions identical to those of each Fund. The Growth & Income Portfolio seeks to provide long-term capital appreciation and dividend income. The Capital Growth Portfolio seeks to provide long-term capital growth. See "Investment Objectives and Policies" and "Additional Information on Investment Policies, Techniques and Risk Factors". Fund Management. VCM provides investment advisory services necessary for the Funds' operations. As of April 30, 1995, VCM had more than $ billion in assets under management. VCM receives monthly compensation from each Fund based on the amount of assets under management. VCM evaluates the performance of the Funds' Portfolio Adviser. The Portfolio Adviser is responsible for the selection of each Portfolio's investments. See "Management of the Trust". The Portfolio Adviser, a wholly owned subsidiary of The Chase Manhattan Corporation, a registered bank holding company, is a commercial bank offering a wide range of banking and investment services to customers throughout the United States and around the world. Its headquarters is at One Chase Manhattan Plaza, New York, New York 10081. The Portfolio Adviser, including its predecessor organizations, has over 100 years of money management experience and renders investment advisory services to others. How to Invest and Redeem. You may purchase shares of each Fund directly from Federated Securities Corp. (the "Distributor") who is the Funds' principal distributor. You may also purchase shares from broker-dealers who have entered into a dealer agreement with the Distributor. The minimum amount required to open an account in a Fund is $3,000 ($2,000 for qualified retirement plans, such a IRAs and Keoghs). The minimum subsequent investment requirement is $200. The Funds have also adopted a Distribution Plan which permits the reimbursement of distribution expenses by a Fund in an amount not to exceed .50% of the average daily net assets of the Fund on an annual basis. See "How to Invest" and "Distribution of Shares of the Fund". You may redeem your shares on any business day at the next determined net asset value calculated after the Funds' Transfer Agent has received the redemption request in proper form. See "Redeeming Shares". Each Fund reserves the right to cease offering shares to new shareholders if the Portfolio Adviser believes that a Fund's size may hamper its effectiveness in managing the Portfolio. In this event, no new accounts will be accepted until further review. Shareholders who have established accounts prior to the closure date will be allowed to add to their investments. Investor Services and Privileges. The Funds offer certain investor services and privileges that may be suited to your particular investment needs, including free Telephone Exchange Privileges, Investment and Withdrawal Plans and various Retirement Plans. See "Investor Services". 3 Dividends. The Funds intend to declare dividends, if any, at least annually for Capital Growth Fund and semi-annually for Growth & Income Fund from net investment income. Dividends, if any, are automatically reinvested in additional Fund shares at net asset value on the payment date and are reflected in the statements we send you, unless you elect to receive them in cash, in which case we will send you a check. See "Tax Matters". Additional Information on Investment Policies, Techniques and Risk Factors. The Funds are non-diversified funds and may be invested in a limited number of issues; thus, there may be greater risk in an investment in these Funds than in diversified investment companies. Moreover, there are potential risks associated with certain of the Funds' investments and additional risk considerations that may be associated with certain techniques and strategies employed by the Funds, including those relating to investments in foreign securities and futures and options transactions. See "Additional Information on Investment Policies, Techniques and Risk Factors". 4 FEE TABLE For a better understanding of the expenses you will incur directly or indirectly when investing in a Fund, a summary for each Fund is set forth below. The summary combines each Fund's operational expenses with the pro rata portion of its Portfolio's operational expenses. See "Management of the Trust". There is no sales commission on any purchase of Fund shares. The trustees believe that the aggregate per share expenses of the Fund and the Portfolio will be approximately equal to the expenses the Fund would incur if its assets were invested directly in the type of securities held by the Portfolio. Shareholder Transaction Expenses Growth & Income Capital Growth Sales Commission on Purchase of Shares .......... NONE NONE Sales Commission on Reinvestment of Dividends ... NONE NONE Sales Commission on Redemption of Shares ........ NONE NONE Estimated Annual Fund Operating Expenses (as a % of average net assets) Management Fees (See "Management of the Trust") . 1.10% 1.10% 12b-1 Fees1 ..................................... .50% .50% Other Expenses (See "Management of the Trust") .. .96% .97% ---- ---- Total Fund Operating Expenses ....................... 2.56% 2.57% Example: You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each time period 1 Year 3 Years ------ ------- Growth and Income ................................... $26 $81 Capital Growth ...................................... $26 $81 This example should not be considered a representation of past or future expenses, and actual expenses may be greater or less than those shown. In addition, the 5% annual return should not be considered representative of past or future returns, and actual returns may be greater or less than the illustration above. - ---------- 1 As of result of distribution fees of .50% per annum of a Fund's average daily net assets, a shareholder who has been in a Fund for 14.5 years may pay more than the economic equivalent of the maximum front-end sales charges permitted by the Rules of the National Association of Securities Dealers, Inc. 5 FINANCIAL HIGHLIGHTS (For a Share Outstanding throughout the Period) The following selected per share data and ratios, insofar as they relate to the period ended February 28, 1995, have not been audited. The related financial statements are included in each Fund's Statement of Additional Information. This information should be read in conjunction with the financial statements and notes thereto.
Blanchard Blanchard Capital Growth Fund Growth & Income Fund For the Period For the Period November 1, 1994* November 1, 1994* through through February 28, 1995 February 28, 1995 (unaudited) (unaudited) ----------------- ----------------- Per Share Operating Performance: Net asset value, beginning of period ......... $ 7.00 $ 7.00 ------ ------ Income from investment operations: Net investment income ...................... .00#(3) .02 Net gains or losses on investments (both realized and unrealized) ........... .04 .11 ------ ------ Net income from investment operations .. .04 .13 ------ ------ Less dividends and distributions: Dividends from investment income-net ....... - (.01) Distributions from realized gains-net ...... - - Change in net asset value .............. .04 .12 ------ ------ Net asset value, end of period ............... $ 7.04 $ 7.12 ====== ====== Total return(1) .............................. .57% 1.86% Ratios/Supplemental Data: Net assets, end of year (000's omitted) .... $1,252 $2,806 Ratio of expenses to average net assets(2) . 2.57% 2.56% Ratio of net investment loss to average net assets(2) ................. (.17%) 1.45% - ---------- * Commencement of operations. # Less than one cent per share. (1) Not annualized. (2) Annualized. Includes expenses of Capital Growth Portfolio and Growth & Income Portfolio, respectively. (3) Calculated based on average shares outstanding.
6 PERFORMANCE OF THE PORTFOLIO ADVISER To achieve its investment objectives, each Fund invests 100% of its assets in a Portfolio which has identical investment objectives. The performance of each Fund therefore depends on the performance of the Portfolio. Because the Funds have no prior performance history, set forth below is a chart presenting historical performance for each Portfolio for one year, five years, and since inception. Each Portfolio's performance has been adjusted to reflect the account opening fee and estimated operating expenses to be charged to shareholders of the Funds. Past performance is not an indication of future performance. 2 CHARTS TO INSERT 7 INVESTMENT OBJECTIVES AND POLICIES Blanchard Growth & Income Fund Investment Objectives and Policies. The Portfolio seeks to achieve its investment objectives of long-term capital appreciation and secondarily, dividend income, by investing primarily (i.e., at least 80% of its assets under normal market conditions) in common stocks. In addition, the Portfolio may invest up to 10% of its net assets in convertible debentures. Convertible debentures are securities which may be converted or exchanged by the holder into shares of the underlying common stock at a stated exchange ratio. A convertible debenture may also be subject to redemption by the issuer but only after a date and under certain circumstances (including a specified price) established on issue. The Portfolio will invest its assets in stocks of issuers (including foreign issuers) ranging from small to medium to large capitalizations. In the opinion of the Portfolio Adviser, small capitalization issuers are those with a market capitalization of under $500 million; medium capitalization issuers are those with a market capitalization ranging between $500 million to $3 billion; and large capitalization issuers are those issuers with a market capitalization in excess of $3 billion. An investor should be aware that investment in small capitalization issuers may be more volatile than investments in issuers with market capitalizations greater than $500 million or less than $3 billion due to the narrow scope of their business activities, and correspondingly greater susceptibility to changes in the business cycle of such small capitalization issuers. For the most part, the Portfolio Adviser will pursue a "contrary opinion" investment approach, selecting common stocks that are currently out of favor with investors in the stock market. These securities are usually characterized by a relatively low price/earnings ratio (using normalized earnings), a low ratio of market price to book value, or underlying assets values that the Portfolio Adviser believes are not fully reflected in the current market price. The Portfolio Adviser will use a similar approach in selecting convertible debentures; in addition to the value of the underlying equity security, the Portfolio Adviser will consider the added investment value of the convertible debenture to produce income for the Portfolio. The Portfolio Adviser believes that the market risk involved in this policy will be moderated somewhat by the anticipated dividend returns on the stocks to be held by the Portfolio. Blanchard Capital Growth Fund Investment Objective and Policies. The Portfolio seeks to achieve its investment objective of long-term capital growth by investing primarily (i.e., at least 80% of its assets under normal circumstances) in common stocks. The Portfolio will invest in stocks of issuers (including foreign issuers) that the Portfolio Adviser believes are likely to benefit from changes or trends brought about by social, economic, demographic and legislative developments considered significant by the Portfolio Adviser. It is expected that the Portfolio's investments will emphasize small and medium-sized companies which the Portfolio Adviser believes have the potential to profit from significant changes or trends of the type described above. This investment policy involves the risks that the changes or trends identified by the Portfolio Adviser will not occur or will not be as significant as projected and that, even if the changes or trends develop, the particular issues held by the Portfolio will not benefit as anticipated from such changes or trends. Dividend income, if any, is a consideration incidental to the Fund's objective of growth of capital. Policies Common to Both Funds Both the Growth & Income Portfolio and the Capital Growth Portfolio will be substantially fully invested and, in normal circumstances, each Portfolio will invest at least 80% of its assets in common stocks which are traded on the New York Stock Exchange and on NASDAQ. The number of stocks paying dividends will 8 fluctuate based on portfolio holdings. U.S. stocks have historically been one of the very best ways to achieve growth. However, each Portfolio also may invest up to 20% of its net assets in stocks of foreign issuers. Investments in foreign securities are subject to certain risks to which investments in domestic securities are not subject, including political or economic instability of the issuer or country of issue and the possibility of the imposition of exchange controls. The Capital Growth Fund is managed somewhat more aggressively than the Growth & Income Fund. However, each Portfolio reserves the right to invest more than 20% of its assets in cash, cash equivalents and debt securities for temporary defensive purposes during periods that the Portfolio Adviser considers to be particularly risky for investment in common stocks. See "Additional Information on Investment Policies Techniques and Risk Factors" on page 9 of this Prospectus and in the discussion in the Statement of Additional Information. The Portfolios may enter into certain transactions commonly referred to as "derivatives" such as stock index futures contracts, options on stock index futures contracts, options on stock indexes and options on equity securities for the purpose of hedging their portfolios. "Additional Information on Investment Policies, Techniques and Risk Factors" and Appendix A contain a more complete description of the hedging instruments to be traded, as well as further information concerning the investment policies and techniques of the Portfolios. In addition, the Statement of Additional Information includes a further discussion of futures and option contracts to be entered into by the Portfolios. Although the Portfolios will enter into futures and option contracts for hedging purposes only, the use of such instruments does involve transaction costs and certain risks, which are discussed below and in Appendix A and in the Statements of Additional Information. The investment objectives of the Funds and the Portfolios are fundamental and may not be changed without approval by a majority of the outstanding shares, as defined in the Investment Company Act of 1940 (the "1940 Act"). Shareholder approval is not required to change the investment policies described above or in "Additional Information on Investment Policies, Techniques and Risk Factors". However, in the event of a change in a Fund's or Portfolio's investment policies, shareholders will be given 30 days prior written notice. ADDITIONAL INFORMATION ON INVESTMENT POLICIES, TECHNIQUES AND RISK FACTORS To the extent the assets of the Portfolios are not invested in common stocks, they will consist of or be invested in cash, cash equivalents and short-term debt securities, such as U.S. Government securities, bank obligations and commercial paper, and in repurchase agreements. See "Investment Objectives, Policies and Restrictions" in the Statements of Additional Information. Among the common stocks in which the Portfolios may invest are stocks of foreign issuers, although at present each Portfolio does not intend to invest more than 20% of its assets in such securities. These securities may represent a greater degree of risk (e.g., risk related to exchange rate fluctuation, tax provisions, war or expropriation) than do securities of domestic issuers. Because the value of securities and the income derived therefrom may fluctuate according to the earnings of the issuers and changes in economic and market conditions, there can be no assurance that the investment objectives of the Funds and the Portfolios will be achieved. Repurchase Agreements. The Portfolios may, when appropriate, enter into repurchase agreements (a purchase of and simultaneous commitment to resell a security at an agreed-upon price and date which is usually not more than seven days from the date of purchase) only with member banks of the Federal Reserve System and security dealers believed creditworthy and only if fully collateralized by U.S. Government obligations or other securities in which that Portfolio is permitted to invest. In the event the seller fails to pay the agreed-to sum on the agreed-upon delivery date, the underlying security could be sold by that Portfolio, but the Portfolio might incur a loss in doing so, and in certain cases may not be permitted to 9 sell the security. As an operating policy, the Portfolios, through the custodian bank, take constructive possession of the collateral underlying repurchase agreements. Additionally, procedures have been established for the Portfolios to monitor, on a daily basis, the market value of the collateral underlying all repurchase agreements to ensure that the collateral is at least 100% of the value of the repurchase agreements. No more than 10% of the total assets of a Portfolio will be invested in securities which are subject to legal or contractual restrictions on resale, including securities that are not readily marketable and repurchase agreements maturing in more than seven days. Portfolio Turnover. It is not intended that the assets of either Portfolio will be invested in securities for the purpose of short-term profits. The Portfolio Adviser anticipates that the annual turnover in each Fund will not be in excess of 100%. However, a Portfolio will dispose of portfolio securities whenever the Portfolio Adviser believes that changes are appropriate. Generally, the primary consideration in placing portfolio securities transactions with broker-dealers for execution is to obtain, and maintain the availability of, execution at the most favorable prices and in the most effective manner possible. For a complete discussion of portfolio transactions and brokerage allocation, see "Portfolio Transactions" in the Statements of Additional Information. Portfolio Securities Lending. Although the Portfolios do not intend to engage in such activity in the ordinary course of business, the Portfolios are permitted to lend securities to broker-dealers and other institutional investors in order to generate additional income. Such loans of portfolio securities may not exceed 30% of the value of a Portfolio's total assets. In connection with such loans, the Portfolios will receive collateral consisting of cash, cash equivalents, U.S. Government securities or irrevocable letters of credit issued by financial institutions. Such collateral will be maintained at all times in an amount equal to at least 100% of the current market value of the securities loaned. The Portfolios can increase their income through the investment of such collateral. The Portfolios continue to be entitled to the interest payable or any dividend-equivalent payments received on a loaned security and, in addition, receive interest on the amount of the loan. However, the receipt of any dividend-equivalent payments by a Portfolio on a loaned security from the borrower will not qualify for the dividends received deduction. Such loans will be terminable at any time upon specified notice. A Portfolio might experience risk of loss if the institutions with which it has engaged in portfolio loan transactions breach their agreements with the Portfolio. The risks in lending portfolio securities, as with other extensions of secured credit, consist of possible delays in receiving additional collateral or in the recovery of the securities or possible loss of rights in the collateral should the borrower experience financial difficulty. Loans will be made only to firms deemed by the Portfolio Adviser to be of good standing and will not be made unless, in the judgment of the Portfolio Adviser, the consideration to be earned from such loans justifies the risk. Non-U.S. Securities. Investing in securities issued by foreign corporations and governments involves considerations and possible risks not typically associated with investing in securities issued by domestic corporations and the U.S. Government. The values of foreign investments are affected by changes in currency rates or exchange control regulations, application of foreign tax laws, including withholding taxes, changes in governmental administration or economic or monetary policy (in the U.S. or other countries) or changed circumstances in dealings between countries. Costs are incurred in connection with conversions between various currencies. In addition, foreign brokerage commissions are generally higher than in the United States, and foreign securities markets may be less liquid, more volatile and less subject to governmental supervision than in the United States, including expropriation, confiscatory taxation, lack of uniform accounting and auditing standards and potential difficulties in enforcing contractual obligations and could be subject to extended settlement periods. The Portfolios may invest in securities denominated in the ECU, which is a "basket" consisting of specified amounts of the currencies of certain member states of the European Community. The specific 10 amounts of currencies comprising the ECU may be adjusted by the Council of Ministers of the European Community to reflect changes in relative values of the underlying currencies. The Portfolios' trustees do not believe that such adjustments will adversely affect holders of ECU-denominated securities or the marketability of such securities. European governments and supranational organizations (discussed below), in particular, issue ECU-denominated securities. The Portfolios may invest in securities issued by supranational organizations such as: the World Bank, which was chartered to finance development projects in developing member countries; the European Community, which is a twelve-nation organization engaged in cooperative economic activities; the European Coal and Steel Community, which is an economic union of various European nations' steel and coal industries; and the Asian Development Bank, which is an international development bank established to lend funds, promote investment and provide technical assistance to member nations of the Asian and Pacific regions. The Portfolios may invest their assets in securities of foreign issuers in the form of sponsored ADRs, EDRs, or other similar securities representing securities of foreign issuers. ADRs are receipts typically issued by an American bank or trust company evidencing ownership of the underlying foreign securities. EDRs are receipts issued by a European financial institution evidencing a similar arrangement. Futures and Options Transactions. A Portfolio may enter into transactions in stock index futures contracts, options on stock index futures contracts, options on stock indexes and options on equity securities, for the purpose of hedging its portfolio to reduce the volatility of the net asset value of its shares. In general, each such transaction involves the establishment of a position which is expected to move in a direction opposite to that of the security or securities being hedged. For example, a Portfolio may enter into a "short" futures or option position for the purpose of protecting against an anticipated decline in the value of securities held in its portfolio. In the event that such a decline occurs, and the hedging transaction is successful, the reduced value of the portfolio securities will be offset, in whole or in part, by a corresponding gain on the futures or option position. Conversely, when a Portfolio is not fully invested in the securities market, and a significant market advance is expected, it may enter into "long" positions in futures or options contracts in order to gain rapid market exposure that may in part or entirely offset increases in the cost of securities intended for purchase. Although the Portfolios are permitted to engage in the purchase and sale of futures contracts and options thereon solely for hedging purposes, the use of such instruments does involve certain transaction costs and risks. A Portfolio's ability effectively to hedge all or a portion of its portfolio through transactions in futures, options on futures or options on stock indexes depends on the degree to which movements in the value of the securities or index underlying such hedging instrument correlate with movements in the value of the relevant portion of the Portfolio's portfolio. The trading of futures and options on indexes involves the additional risk of imperfect correlation between movements in the futures or option price and the value of the underlying index. While the Portfolios will establish a future or option position only if there appears to be a liquid secondary market therefor, there can be no assurance that such a market will exist for any particular futures or option contract at any specific time. In such event, it may not be possible to close out a position held by a Portfolio, which could require the Portfolio to purchase or sell the instrument underlying the position, make or receive a cash settlement, or meet ongoing variation margin requirements. Investments in futures contracts on fixed income securities and related indexes involve the risk that if the Portfolio Adviser's investment judgment concerning the general direction of interest rates is incorrect, a Portfolio's overall performance may be poorer than if it had not entered into any such contract. For additional information concerning the use and risks involved in the acquisition, ownership or sale of futures contracts and options thereon, including certain percentage limitations on the use of such instruments, see "Investment Objectives, Policies and Restrictions" in the Statements of Additional Information. 11 MANAGEMENT OF THE FUNDS Board of Trustees. The Board of Trustees (the "Board" or the "Trustees") is responsible for managing the business affairs of the Funds and for exercising all of the powers of the Funds except those reserved for the shareholders. The Executive Committee of the Board of Trustees handles the Board's responsibilities between meetings of the Board. Investment Adviser. VCM is responsible for managing the Funds and overseeing the investment of their assets, subject at all times to the supervision of the Board members. In addition, VCM selects, monitors and evaluates the Portfolio Advisers. VCM will review the Portfolio Advisers' performance records periodically, and will make changes if necessary, subject to Board member and shareholder approval. Advisory Fees. Under the terms of the Investment Advisory Contract, VCM receives a monthly fee of .70% of each Fund's average daily net assets and the Portfolio Adviser receives .40% per annum of each Fund's average daily net assets directly from the Portfolio, as described below. The portion of the fee based upon the average daily net assets of the Fund shall be accrued daily at the rate of 1/365th of the applicable percentage applied to the daily net assets of the Fund. The investment advisory contract provides for the voluntary waiver of expenses by VCM from time to time. VCM can terminate this voluntary waiver of expenses at any time with respect to a Fund at its sole discretion. VCM has also undertaken to reimburse the Funds for operating expenses in excess of limitations established by certain states. The Portfolios pay for all their expenses including legal and auditing expenses; registration fees; taxes on the sales of portfolio securities; brokerage commissions; Portfolio trustee fees, expenses connected with the execution, recording and settlement of security transactions; fees and expenses of the Portfolios' custodian for all services to the Portfolios; expenses of preparing and mailing reports to investors and to government agencies and commissions; expenses of meetings of investors and the advisory fees of .40% of each Portfolio's average daily net assets payable to the Portfolio Adviser under the Investment Advisory Agreements. In addition, each Portfolio pays an administrative fee to The Chase Manhattan Trust Corporation Limited ("CMTC"), at an annual rate of .05% of the Portfolio's average daily net assets pursuant to an Administration Agreement wherein CMTC provides facilities and personnel necessary to operate the Portfolio. VCM's Background. Virtus Capital Management, Inc., a Maryland corporation formed in 1995, is a wholly owned subsidiary of Signet Banking Corporation. Signet Banking Corporation is a multi-state, multi-bank holding company which has provided investment management services since 1956. VCM, which is a registered investment adviser, manages, in addition to the Funds, The Virtus Funds, three equity common trust funds with $39 million in assets and three fixed income common trust funds with $221 million in assets. As part of their regular banking operations, Signet Bank may make loans to public companies. PORTFOLIO ADVISORY SERVICES The Portfolio Adviser. The Portfolio Adviser, a wholly owned subsidiary of The Chase Manhattan Corporation, a registered bank holding company, is a commercial bank offering a wide range of banking and investment services to customers throughout the United States and around the world. Its headquarters is at One Chase Manhattan 12 Plaza, New York, NY 10081. The Portfolio Adviser, including its predecessor organizations, has over 100 years of money management experience and renders investment advisory services to others. David Klassen and Greg Adams, Vice Presidents of the Portfolio Adviser, are responsible for the day-to-day management of the Portfolios. Each is a member of the Chase Private Bank's in-house investment management research team, specializing in technology and financial issues and uses a model which scans over 1,600 equity securities in their quest for attractive value. Mr. Klassen, Head of U.S. Equity Funds Management and Research for Chase has been with the Portfolio Adviser since March, 1992 and Mr. Adams, Director of U.S. Equity Research for Chase has been with the Portfolio Adviser since 1987. Messrs. Klassen and Adams have co-managed each Portfolio since March, 1995. According to Morningstar, Inc. for the one year, three year and five year periods ended March 31, 1995, the Growth & Income Portfolio was ranked #284 out of 356 growth and income funds for one year; #136 out of 227 growth and income funds for three years and #2 out of 184 growth and income funds for five years, respectively. For the one year, three year and five year periods ended March 31, 1995, the Capital Growth Portfolio was ranked #446 out of 664 capital growth funds for one year; #73 out of 366 capital growth funds for three years and #7 out of 290 growth and income funds for five years, respectively. The Growth & Income Portfolio was rated four stars, and the Capital Growth Portfolio was rated four stars, by Morningstar, Inc. for the period ending March 31, 1995. The Portfolio Adviser and its affiliates may have deposit, loan and other commercial banking relationships with the issuers of securities purchased on behalf of the Portfolios, including outstanding loans to such issuers which may be repaid in whole or in part with the proceeds of securities so purchased. The Portfolio Adviser has informed the Portfolios that in making its investment decisions, it does not obtain or use material inside information in the possession of any other division or department of the Portfolio Adviser. Glass-Steagall Act. The Portfolio Adviser has received the opinion of its legal counsel that it may provide services described in its Investment Advisory Agreements and Custodian Agreements with the Portfolios, without violating the federal banking law commonly known as the Glass-Steagall Act. The Act generally bars banks from publicly underwriting or distributing certain securities. Decisions of the U.S. Supreme Court and banking regulators support the position that a bank may act as investment adviser to a registered, open-ended investment company. Based on the advice of its counsel, the Portfolio Adviser believes that it may serve as investment adviser to a registered, open-end investment company. Regarding the performance of custodial activities, the staff of the Office of the Comptroller of the Currency, which supervises national banks, has issued opinion letters stating that national banks may engage in custodial activities. Therefore, the Portfolio Adviser believes, based on advice of counsel, that it may serve as Custodian to the Portfolios as an appropriate, incidental national banking function and as a proper adjunct to its serving as Portfolio Adviser to the Portfolios. Possible future changes in federal law or administrative or judicial interpretations of current or future law, however, could prevent the Portfolio Adviser from continuing to perform investment advisory or custodial services for the Portfolios. If that occurred, the Funds' trustees would then consider what action would be in the best interest of the Funds' shareholders. In addition, state securities laws on this issue may differ from the interpretation of federal law expressed herein and banks and financial institutions may be required to register as dealers pursuant to state law. 13 HOW TO INVEST You may purchase shares of any Fund from Federated Securities Corp., the Funds' principal Distributor. You may also purchase shares from broker-dealers who have entered into a dealer agreement with the Distributor at net asset value which is computed once daily for BAEF and BTMMF as of the close of the New York Stock Exchange (currently 4:00 p.m., New York time) and for the other Funds as of the close of the options exchanges (normally 4:15 P.M. New York time). If your order is received after the above times, your shares will be purchased at the net asset value on the next business day. Each Fund's net asset value per share is determined by dividing the value of that Fund's net assets by the total number of its shares outstanding. Each Fund determines the net asset value of its shares on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in its securities to affect materially its net asset value per share. For your initial investment, there is a $3,000 minimum requirement. The minimum initial investment requirement for qualified pension plans (IRAs, Keoghs, etc.) is $2,000. The minimum investment requirement for additional investments in a Fund is at least $200 per investment. (The foregoing minimum investment requirements may be modified or waived at any time at our discretion.) We charge no redemption fee when you redeem your shares and there is no fee on reinvestment of any dividends or distributions. Purchases By Mail To purchase shares of a Fund by mail, simply send a completed Application (included with this Prospectus or obtainable from the Fund), to the Blanchard Group of Funds, c/o Mutual Funds Service Company, P.O. Box 2798, Boston, Massachusetts 02208-2798, together with a check payable to the Blanchard Group of Funds in payment for the shares. Mutual Funds Service Company is an affiliate of United States Trust Company of New York. If you need assistance in completing the application, call us at 1-800-829-3863. Our investor services representatives are here to help you. All purchases must be made in U.S. dollars and checks must be drawn on a United States bank. Payment for shares may be not be made by third party checks, however, second party checks are acceptable when properly endorsed. We reserve the right to limit the number of checks for one account processed at one time. If your check does not clear, your purchase will be cancelled and you could be liable for any losses or fees incurred. Payments transmitted by check are accepted subject to collection at full face amount. Your purchase order becomes effective when it is received in proper form by the Fund's Transfer Agent. Purchase orders must be received by the Funds' Transfer Agent before 4:15 P.M., New York time, or your purchase will occur the following business day. A purchase order will not become effective until it is received in proper form by the Transfer Agent. Purchases By Wire. You may also purchase shares by bank wire. For opening new accounts in this manner, please call us toll free at 1-800-829-3863 before wiring your funds, and furnish the following information: the account registration and address, and your taxpayer identification number (for individuals, a Social Security number). When making additional investments by wire to your existing accounts, please provide your account numbers. You must include your name and telephone number, the amount being wired and the name of the wiring bank with both new and existing account purchases. Initial purchases by wire must be followed by a completed Application within seven days. You should instruct your bank to wire Federal funds: United States Trust Company of New York, 114 West 47th Street, New York, New York 10036 ABA #021001318 Credit Account #20-7324-2, indicating the name of the Fund, your account number and the account registration. 14 Automatic Investment Plans. Regular monthly purchases of shares may be made by direct deposit of Social Security and certain other government checks into your account. Fund shares may be purchased at regular intervals selected by you by automatic transferral of funds from a bank checking account that you may designate. All such purchases require a minimum of $100 per transaction. Call or write our investor services department for information and forms required to establish these Plans. Electronic Funds Transfers (EFT)--Subsequent investments may be made by electronic transfer of funds from an account maintained in a bank or other domestic financial institution that is an Automated Clearing House member (ACH). To enroll in this program, you must file an application with Blanchard Group of Funds by calling 1-800-829-3863. You may begin transferring funds under the program only after 15 days from the date your EFT Application is received by the transfer agent, Mutual Funds Service Co. You must direct the institution to transmit immediately available funds through the Automated Clearing House to U.S. Trust Co. of New York ABA #021001318 CR A/C #20-7324-2 with instructions to credit your Fund account. The instructions must specify your Fund account registration and your Fund account number. Redemption proceeds will be on deposit in your designated account at an Automated Clearing House member bank ordinarily two days after receipt of the redemption request. Direct deposit of dividends or systematic disbursements from your account will be on deposit in your designated account at an Automated Clearing House member bank ordinarily two days after a dividend payment or disbursement is effected. General Information All ordinary income, dividends and capital gain distributions, if any, are automatically reinvested at net asset value in additional Fund shares unless we receive written notice from you, at least 30 days prior to the record date of such distribution, requesting that your dividends and distributions be distributed to you in cash. See "Tax Matters". We reserve the right to suspend the offering of any Fund shares for a period of time. We also reserve the right to reject any purchase order. No share certificates will be issued for shares unless requested in writing. In order to facilitate redemptions and transfers, most shareholders elect not to receive certificates. Shares are held in unissued form by the Transfer Agent. Shares for which certificates have been issued cannot be redeemed, unless the certificates are received together with the redemption request in proper form. Share certificates are not issued for fractional shares. INVESTOR SERVICES Automatic Withdrawal Plan If you purchase $10,000 or more of Fund shares, you may establish an Automatic Withdrawal Plan to authorize a specified dollar amount to be paid periodically to a designated payee. Under this Plan, all income dividends and capital gains distributions will be reinvested in shares in your account at the applicable payment dates' closing net asset value. Your specified withdrawal payments are made monthly or quarterly (on or about the 10th day) in any amount you choose, but not less than $100 per month or $300 quarterly. Please note that any redemptions of your shares, which may result in a gain or loss for tax purposes, may involve the use of principal, and may eventually use up all of the shares in your account. Such payments do not provide a guaranteed annuity and may be terminated for any shareholder if the value of the account drops below $10,000 due to transfer or 15 redemption of shares. In such a case, the shareholder will be notified that the withdrawal payments will be terminated. The cost of administering the Automatic Withdrawal Plan for the benefit of shareholders is a Fund expense. Retirement Plans We offer a Prototype Pension and Profit Sharing Plan, including Keogh Plans, IRAs, SEP-IRA Plans, IRA Rollover Accounts and 403(b) Plans. Plan support services are available by calling us at 1-800-829-3863. Exchange Privilege You may exchange your Fund shares for shares of another Fund in the Blanchard Group of Funds on the basis of relative net asset values per share at the time of exchange. No fees are charged when you exchange from one Fund to another within the Blanchard Group of Funds. Before making an exchange, you should read the Prospectus concerning the Fund into which your exchange is being made. The other funds currently offered in the Blanchard Group of Funds are Blanchard Global Growth Fund, Blanchard Precious Metals Fund, Inc., Blanchard 100% Treasury Money Market Fund, Blanchard Short-Term Global Income Fund, Blanchard American Equity Fund, Blanchard Flexible Income Fund, Blanchard Short-Term Bond Fund, Blanchard Flexible Tax-Free Bond Fund and Blanchard Emerging Markets & Income Fund. To request an exchange by telephone, simply call 1-800-462-9102, prior to 4:00 P.M., New York time. Exchanges can be made in this manner only after you have completed and sent to the Transfer Agent the telephone exchange authorization form that is included on the New Account Application accompanying this Prospectus and only if your account registration has not changed within the last 30 days. It is the Funds' policy to mail to you at your address of record, within five business days after any telephone call transaction, a written confirmation statement of the transaction. In order to protect itself and shareholders from liability for unauthorized or fradulent telephone transactions, the Funds will use reasonable procedures such as recording calls in an attempt to verify the identity of a person making a telephone redemption request. As a result of the Funds' policy, neither the Funds nor the Transfer Agent will be responsible for any claims, losses or expenses for acting on telephone instructions that they reasonably believe to be genuine. Since you may bear the risk of loss in the event of an unauthorized telephone transaction, you should verify the accuracy of telephone transactions immediately upon receipt of your confirmation statement. Exchanges can only be made between accounts with identical account registration and in states where shares of the other fund are qualified for sale. We do not place any limit on the number of exchanges that may be made and charge no fee for effecting an exchange. The dollar amount of an exchange must meet the initial investment requirement of the fund into which the exchange is being made. All subsequent exchanges into that fund must be at least $1,000. We may modify or suspend the Exchange Privilege at any time upon 60 days' written notice. Any exchange of shares is, in effect, a redemption of shares in one Fund and a purchase of the other fund. You should consider the possible tax effects of an exchange. To prevent excessive trading between Funds to the disadvantage of other shareholders, we reserve the right to modify or terminate this Privilege with respect to any shareholder. A completed Purchase Application must be received by the Transfer Agent before the Automatic Withdrawal Plan or Exchange Privilege may be used. 16 HOW TO REDEEM You may redeem your shares on any business day at the next determined net asset value calculated after your redemption request has been accepted by the Transfer Agent as described below. By Telephone. You may redeem your shares by telephone if you call the Transfer Agent at 1-800-462-9102, prior to 4:15 P.M., New York time. All calls will be recorded. Redemptions of Fund shares can be made in this manner only after you have executed and filed with the Transfer Agent the telephone redemption authorization form which may be obtained from the Funds or the Transfer Agent. You may elect on the telephone redemption authorization form to have a redemption in any amount of $250 or more mailed either to your registered address, to your bank account, or to any other person you may designate. Should you wish to revise these instructions, simply complete and file a new telephone redemption authorization form. There is no charge for this service. As long as the identification procedures described above are followed, neither the Funds nor the Transfer Agent will be responsible for any claims, losses or expenses for acting on telephone instructions that they reasonably believe to be genuine. See "Investor Services--Exchange Privilege," for additional information with respect to losses resulting from unauthorized telephone transactions. You may also request, by placing a call to the applicable telephone number set forth above, redemption proceeds to be wired directly to the bank account that you have designated on the authorization form. The minimum amount that may be redeemed in this manner is $1,000. A check for proceeds of less than $1,000 will be mailed to your address of record. The Funds do not impose a charge for this service. However, the proceeds of a wire redemption may be subject to the usual and customary charges imposed by United States Trust Company of New York for the wiring of funds. Under extraordinary market conditions, it may be difficult for you to redeem your shares by telephone. Under these circumstances, you should consider redeeming your shares by mail, as described below. By Mail. All other redemption requests should be made in writing to the Blanchard Group of Funds, c/o Mutual Funds Service Company (an affiliate of United States Trust Company of New York), P.O. Box 2798, Boston, Massachusetts 02208-2798, the Funds' Transfer Agent. Where share certificates have been issued, the certificates must be endorsed and must accompany the redemption request. Signatures on redemption request for amounts in excess of $25,000 and endorsed share certificates submitted for redemption must be accompanied by signature guarantees from any eligible guarantor institution approved by the Transfer Agent in accordance with its Standards, Procedures and Guidelines for the Acceptance of Signature Guarantees ("Signature Guarantee Guidelines"). Eligible guarantor institutions generally include banks, broker-dealers, credit unions, national securities exchanges, registered securities associations, clearing agencies and savings associations. All eligible guarantor institutions must participate in the Securities Transfer Agents Medallion Program ("STAMP") in order to be approved by the Transfer Agent pursuant to the Signature Guarantee Guidelines. Copies of the Signature Guarantee Guidelines and information on STAMP can be obtained from the Transfer Agent at 1-800-462-9102. Signatures on redemption requests for any amount must be guaranteed (as described above) if the proceeds are not to be paid to the registered owner at the registered address, or the registered address has changed within the previous 60 days. The letter of instruction or a stock assignment must specify the account number and the exact number of shares or dollar amount to be redeemed. It must be signed by all registered shareholders in precisely the same way as originally registered. The letter of instruction must also include any other supporting legal documents, if required, in the case of estates, trusts, guardianships, custodianships, corporations, partnerships, pension or profit sharing plans, or other organizations. 17 General Information. Your redemption request becomes effective when it is received in proper form by the Transfer Agent prior to 4:15 P.M. New York time, or your redemption will occur on the following business day. We will make payment for redeemed shares within seven days after receipt by the Transfer Agent. However, we may delay the forwarding of redemption proceeds on shares which were recently purchased until the purchase check has cleared, which may take up to 15 days or more. We may suspend the right of redemption when the New York Stock Exchange is closed or when trading on the Exchange is restricted, and under certain extraordinary circumstances in accordance with the rules of the SEC. Due to the relatively high cost of handling small investments, we reserve the right upon 60 days' written notice to involuntarily redeem, at net asset value, the shares of any shareholder whose account has a value of less than $1,000, other than as a result of a decline in the net asset value per share. We do not presently contemplate making such involuntary redemptions and will not redeem any shares held in tax-sheltered retirement plans in this category. We also reserve the right upon notice to shareholders to charge a fee for any services provided herein that are currently free of charge. DISTRIBUTION OF SHARES OF THE FUNDS Federated Securities Corp. is the principal distributor for shares of the Funds. It is a Pennsylvania corporation organized on November 14, 1969, and is the principal distributor for a number of investment companies. Federated Securities Corp. is a subsidiary of Federated Investors. Distribution Plan. According to the provisions of a distribution plan adopted pursuant to Investment Company Act Rule 12b-1, the distributor may select brokers and dealers to provide distribution and administrative services as to shares of the Funds. The distributor may also select administrators (including financial institutions, fiduciaries, custodians for public funds and investment advisers) to provide administrative services. Administrative services may include, but are not limited to, the following functions: 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 shares; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as each Fund reasonably requests for its shares. Brokers, dealers, and administrators will receive fees based upon shares owned by their clients or customers. The schedules of such fees and the basis upon which such fees will be paid will be determined from time to time by the Board of Trustees, provided that for any period the total amount of fees representing an expense to the Trust shall not exceed an annual rate of .50 of 1% of the average daily net assets of shares of each Fund held in the accounts during the period for which the brokers, dealers, and administrators provide services. Any fees paid by the distributor with respect to shares of a Fund pursuant to the distribution plan will be reimbursed by the Trust from the assets of the shares of that Fund. The distributor will, periodically, uniformly offer to pay cash or promotional incentives in the form of trips to sales seminars at luxury resorts, tickets or other items to all dealers selling shares of the Funds. Such payments will be predicated upon the amount of shares of the Funds that are sold by the dealer. Such payments, if made, will be in addition to amounts paid under the distribution plan and will not be an expense of a Fund. Administrative Arrangements. The distributor may pay financial institutions a fee based upon the average net asset value of shares of their customers invested in the Trust for providing administrative services. This fee, if paid, will be reimbursed by VCM and not the Trust. 18 Glass-Steagall Act. The Glass-Steagall Act prohibits a depository institution (such as a commercial bank or a savings and loan association) from being an underwriter or distributor of most securities. In the event the Glass-Steagall Act is deemed to prohibit depository institutions from acting in the administrative capacities described above or should Congress relax current restrictions on depository institutions, the Board of Trustees will consider appropriate changes in the administrative services. 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. Administrative Services. Federated Administrative Services, a subsidiary of Federated Investors, provides the Funds with certain administrative personnel and services necessary to operate each Fund and the separate classes. Such services include shareholder servicing and certain legal and accounting services. Federated Administrative Services 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 The administrative fee received during any fiscal year shall be at least $75,000 per Fund. Federated Administrative Services may voluntarily waive a portion of its fee. Transfer Agent and Dividend Disbursing Agent. Federated Services Company, Pittsburgh, Pennsylvania, is transfer agent for the Shares of the Funds and dividend disbursing agent for the Funds. Expenses of the Funds Each Fund pays all of its own expenses and its allocable share of the Trust's expenses. The Trust's 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; registering the Trust; Trustees fees; auditors' fees; the cost of meetings of Board members; legal fees of the Trust; association membership dues and such nonrecurring and extraordinary items as may arise. Each Fund's expenses for which holders of shares may pay their allocable portion include, but are not limited to: registering each Fund and shares of the Fund; investment advisory services; taxes and commissions; custodian fees; insurance premiums; auditors' fees; and such nonrecurring and extraordinary items as may arise. TAX MATTERS The Funds intend to qualify each year and elect to be treated as separate "regulated investment companies" under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). A regulated investment company that distributes all of its taxable income to its shareholders in accordance with the timing requirements imposed by the Code, which the Funds intend to do, is not subject to Federal income tax on the amounts so distributed. If for any taxable year a Fund does not qualify for the treatment as a 19 regulated investment company, all its taxable income will be subject to tax at regular corporate rates without any deduction for distributions to its shareholders, and such distributions, in turn, will be taxable to the shareholders as ordinary dividends to the extent of the Fund's current and accumulated earnings and profits. Because the Funds invest all their assets in Portfolios which are classified as partnerships for federal income tax purposes, each will be deemed to own a proportionate share of the income of the Portfolio in which it invests, for purposes of determining whether it qualifies as a regulated investment company. The Trust is organized as a Massachusetts business trust and, under current law, is not liable for any income or franchise tax in the Commonwealth of Massachusetts as long as each Fund (and each other series of the Trust) qualifies as a regulated investment company under the Code. Distributions by a Fund of its ordinary income (net of expenses) and the excess, if any, of its net short-term capital gain over its net long-term capital loss are generally taxable to shareholders as ordinary income. Such distributions are treated as dividends for Federal income tax purposes. A portion of the ordinary income dividends paid by a Fund with respect to a given year (essentially, the portion attributable to qualifying dividends received by the underlying Portfolio from domestic corporations during the year) may qualify for the 70% dividends-received deductions for corporate shareholders. Distributions by a Fund of the excess, if any, of its net long-term capital gain over its net short-term capital loss are designated as capital gain dividends and are taxable to shareholders as long-term capital gains, regardless of their holding periods in their shares. Ordinary income and capital gain dividends from a Fund may also be subject to state and local taxes. Investors should carefully consider the tax implications of purchasing shares just prior to a dividend record date. Investors purchasing shares just prior to an ordinary income or capital gain dividend record date will be taxed on the entire dividend received, even though their cost for shares already reflected the amount of such dividend. Distributions to shareholders will be treated in the same manner for Federal income tax purposes whether received in cash or reinvested in additional Fund shares. In general, distributions by a Fund are taken into account by shareholders in the year in which they are made. However, certain distributions made during January will be treated as having been paid by a Fund and received by its shareholders on December 31 of the preceding year. A statement setting forth the federal income tax status of all distributions made (or deemed made) during the year, including the allocation to ordinary income dividends (and any portion thereof which qualifies for the dividends-received deduction for corporations) and capital gain dividends, will be sent to each Fund's shareholders promptly after the end of each year. A shareholder will recognize gains or losses upon the sale or redemption of shares of a Fund in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. Any loss realized upon a taxable disposition of shares within six months from the date of their purchase will be treated as a long-term capital loss to the extent of any capital gain dividends received on such shares. All or a portion of any loss realized upon a taxable disposition of shares of a Fund may be disallowed if other shares of the Fund are purchased within 30 days before or after such disposition. Under the back-up withholding rules of the Code, a shareholder may be subject to 31% withholding of Federal income tax on dividends and redemption payments made by a Fund. To avoid this back-up withholding, you must provide your Fund with a correct taxpayer identification number (which for an individual is usually one's Social Security number) or certify that you are a corporation or otherwise exempt from or not subject to back-up withholding. The foregoing discussion of Federal income tax consequences is based on tax laws and regulations in effect on the date of this Prospectus and is subject to change by legislative or administrative action. You 20 should also review the more detailed discussion of Federal income tax considerations in the Statement of Additional Information for your Fund. In addition, you should consult with your own tax advisor as to the tax consequences of investing in the Funds, including the application of state and local taxes to you, which may differ from the Federal income tax consequences described above. PERFORMANCE COMPUTATION INFORMATION Advertisements and communications to investors regarding the Funds may cite certain performance, ranking and rating information of the Funds and the Portfolios and may make performance comparisons to other funds or to relevant indices, as described below. Total Return. Cumulative total return data is computed by considering all elements of return, including reinvestment of dividends and capital gains distribution, over a stated period of time. Cumulative total return figures are not annualized and represent the aggregate percentage or dollar value change over the period in question. Average annual return will be quoted for at least the one, five and ten year periods ending on a recent calendar quarter (or if such periods have not yet elapsed, at the end of a shorter period corresponding to the life of the Fund for performance purposes). Average annual total return figures are annualized and, therefore, represent the average annual percentage change over the period in question. Comparative Results. From time to time in advertisements or sales material, a Fund may discuss its performance rating and may be compared to the performance of other mutual funds or mutual fund indexes as published by widely recognized independent mutual fund reporting services. In addition, because the Funds invest 100% of their assets in the Portfolios which have identical investment objectives, each Fund may cite the performance and ranking information of its Portfolio (which includes the performance of predecessor mutual funds prior to their conversion to the Portfolios) and may make certain performance, ranking and rating comparisons. The Funds may also discuss the past performance, ranking and rating of the Portfolio Adviser, and compare its performance to various investment indexes. The Funds may use performance information as reported in publications of general interest, national financial and industry publications. In addition, a Fund may compare its total return, or the total return of indexes of U.S. markets, world markets, individual countries undergoing privatization, or of world indexes of countries undergoing privatization, to that of other mutual funds, individual country indexes, or other recognized indexes. From time to time, the Funds may provide information on certain markets or countries and specific equity securities and quote published editorial comments and/or information from newspapers, magazines, investment newsletters and other publications. The Funds may also compare the historical returns on various investments, performance indexes of those investments or economic indicators. In addition, a Fund may reprint articles about the Fund and provide them to prospective shareholders. The Distributor may also make available economic, financial and investment reports to shareholders and prospective shareholders. In order to describe these reports, the Funds may include descriptive information on the reports in advertising literature sent to the public prior to the mailing of a prospectus. Performance information may be quoted numerically or may be presented in a table, graph, chart or other illustration. ADDITIONAL INFORMATION ABOUT THE FUNDS AND THE PORTFOLIOS The Funds The Funds are non-diversified series of Blanchard Funds, a Massachusetts business trust organized on January 24, 1986 (the "Trust"), which currently consists of ten series of shares. The other series of the 21 Trust's shares of beneficial interest, which are offered pursuant to a separate prospectus, are Blanchard Global Growth, Blanchard 100% Treasury Money Market, Blanchard Short-Term Global Income, Blanchard American Equity, Blanchard Flexible Income, Blanchard Short-Term Bond, Blanchard Flexible Tax-Free Bond Fund and Blanchard Worldwide Emerging Markets Fund. The Funds are classified as "non-diversified" investment companies under the 1940 Act, which means that each Fund is not limited by the 1940 Act in the proportion of its assets that may be invested in the securities of a single issuer. The Funds intend, however, to comply with the diversification requirements imposed by the U.S. Internal Revenue Code of 1986, as amended, for qualification as a regulated investment company. See "Tax Matters" in the Prospectus and in the Statements of Additional Information. Investor Meetings and Voting Under Massachusetts law, the Trust and its series are generally not required to hold annual or special shareholder meetings. However, special meetings of shareholders may be held for such purposes as electing trustees, changing fundamental policies, approving an investment management/advisory agreement or approving a distribution and marketing plan, if any, and, at the request of the shareholders, to replace trustees. Shareholders holding 10% or more of the Trust's outstanding shares may call a special meeting of shareholders. Shareholders may remove trustees from office whenever not less than two-thirds of the outstanding shares either present a written declaration to the Transfer Agent or vote at a meeting called for this purpose. Shareholders shall be given access to a list of the names and addresses of all other shareholders, the number of shareholders and the cost of mailing a request to them. Whenever a vote is requested on matters pertaining to a Portfolio, the Trust will hold a meeting of that Fund's shareholders and will cast its vote as instructed by such Fund's shareholders. Shares of a Fund for which no voting instructions have been received will be voted in the same proportion as those shares for which voting instructions are received. As with any mutual fund, other investors in that Portfolio could control the results of voting at the Portfolio level. Each Fund's shares represent shares of beneficial interest. Each share has equal rights with respect to voting matters of that Fund. In the event of dissolution or liquidation of a Fund, holders of Fund shares will receive pro rata, subject to the rights of creditors, the proceeds of the sale of the Fund's assets less its liabilities. There are no preemptive or conversion rights applicable to the shares of the Funds. Shares of the Funds, when issued, will be fully paid, non-assessable and transferable. The trustees may create additional series or classes of shares without shareholder approval. Each series of the Trust is responsible only for its own expenses and operating costs and incurs no liability with respect to the expenses and costs of any other series, other than those which affect the series as a group and are allocated among the series based upon their relative average net assets during the year. The Portfolios Each Portfolio is organized as a trust under the laws of the State of New York. Each Portfolio's Declaration of Trust provides that the Funds and other entities investing in the Portfolios (e.g., other investment companies, insurance company separate accounts and common and commingled trust funds) will each be liable for all obligations of that Portfolio. However, the risk of a Fund's incurring financial loss on account of such liability is limited to circumstances in which both inadequate insurance existed and the Portfolio itself was unable to meet its obligations. Accordingly, the trustees believe that neither the Funds nor their shareholders will be adversely affected by reason of the Funds' investing in the Portfolios. Unique Characteristics of the Fund and Portfolio Structure Unlike other mutual funds which directly acquire and manage their own portfolio securities, each Fund is an open-end investment management company which seeks to achieve its investment objectives by 22 investing 100% of its assets in a Portfolio, which is a separate registered investment company with identical investment objectives as the Fund. The investment objectives of the Funds and the Portfolios may not be changed without shareholder approval. Shareholders will be provided with written notice 30 days prior to any such changes in investment objectives. Therefore, an investor's interest in a Portfolio's securities is indirect. In addition to selling a beneficial interest to a Fund, a Portfolio may sell beneficial interests to other mutual funds or institutional investors. Such investors will invest in that Portfolio on the same terms and conditions and will pay a proportionate share of the Portfolio's expenses. However, other investors investing in a Portfolio are not required to buy their shares at the same public offering prices as the Funds. Investors in the Funds should be aware that these differences may result in differences in returns experienced by investors in the different funds that invest in the Portfolios. Such differences in returns are also present in other mutual fund structures. Small funds investing in the Portfolios may be materially affected by the actions of larger funds investing in the Portfolios. For example, if a large fund withdraws from a Portfolio, the remaining funds may experience higher pro rata operating expenses, thereby producing lower returns. Additionally, a Portfolio may become less diverse, resulting in increased portfolio risk. (However, this possibility also exists for traditionally structured funds which have large or institutional investors.) Also, funds with a greater pro rata ownership in a Portfolio could have effective voting control of the operations of that Portfolio. Certain changes in a Portfolio's investment objectives, policies or restrictions may require a Fund to redeem its investment in that Portfolio. Any such withdrawal could result in a distribution in kind of portfolio securities (as opposed to a cash distribution from the Portfolio). A Fund could incur brokerage fees or other transaction costs in converting such securities to cash. The distribution in kind may also result in a less diversified portfolio of investments or adversely affect the liquidity of a Fund. In addition, the investment of a Fund may be withdrawn from a Portfolio at any time if the Board of Trustees determines that it is in the best interest of that Fund to do so. Upon any such withdrawal, the Board of Trustees would consider what action might be taken, including the investment of all of the assets of such Fund in another pooled investment entity having the same investment objectives as the Fund or retaining an investment adviser to manage that Fund's assets in accordance with the investment policies of the Portfolio. In addition to the Funds, other mutual funds invest in the Portfolios. Information on these other feeder funds may be obtained by calling 1-800-348-4782. See "Investment Objectives and Polices", "Additional Information on Investment Policies, Techniques and Risk Factors" and "Management of the Trust" for more information. OTHER INFORMATION This Prospectus omits certain information contained in the registration statement of the Funds filed with the SEC. Copies of the registration statement, including items omitted herein, may be obtained from the SEC by paying the charges prescribed under its rules and regulations. The Statements of Additional Information included in the registration statement may be obtained without charge from the Funds. For information about the trustees and officers of the Funds and the Portfolios see the Statements of Additional Information. The Code of Ethics of the Portfolio Adviser and the Funds prohibits all affiliated personnel from engaging in personal investment activities which compete with or attempt to take advantage of the Funds' planned portfolio transactions. The objective of the Code of Ethics of both the Funds and Portfolio Adviser is that their operations be carried out for the exclusive benefit of the Funds' shareholders. Both organizations maintain careful monitoring of compliance with the Code of Ethics. 23 No person has been authorized to give any information or to make any representations other than those contained in this Prospectus and in the Statements of Additional Information, and information or representations not herein contained, if given or made, must not be relied upon as having been authorized by the Funds. This Prospectus does not constitute an offer or solicitation in any jurisdiction in which such offering may not lawfully be made. Counsel and Independent Accountants. The firm of Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third Avenue, New York, New York 10022, is legal counsel for the Funds. Price Waterhouse LLP, 1177 Avenue of the Americas, New York, New York 10036, has been appointed the independent accountants for the Funds. 24 APPENDIX A Description of Futures Contracts and Options Thereon Futures Contracts. A futures contract is a bilateral agreement providing for the purchase and sale of a specified type and amount of a financial instrument, or, in the case of futures contracts on indexes of securities, for the making and acceptance of a cash settlement, at a stated time in the future for a fixed price. By its terms, a futures contract provides for a specified settlement date on which, in the case of the majority of interest rate futures contracts, the fixed income securities underlying a contract are delivered by the seller and paid for by the purchaser, or on which, in the case of a stock index futures contract, an amount equal to a dollar amount multiplied by the difference between the value of a stock index at the close of the last trading day of the contract and the value of such index at the time the futures contract was originally entered into is settled between the purchaser and seller in cash. The purchase or sale of a futures contract differs from the purchase or sale of a security in that no purchase price is paid or received at the time the contract is entered into. Instead, an amount of cash or cash equivalents, the value of which may vary but is generally equal to 2% or less of the value of the contract, must be deposited with the broker as initial deposit or "margin". Subsequent payments to and from the broker, referred to as "variation margin", are made on a daily basis as the value of the index underlying the futures contract fluctuates, making positions in the futures contract more or less valuable, a process known as "marking to the market". At any time prior to the expiration of a futures contract, a trader may elect to close out its position by taking an opposite position, subject to the availability of a secondary market, which will operate to terminate the initial position. At that time, a final determination of variation margin is made and any loss experienced by a party is required to be paid to the exchange clearing corporation, while any profit due to a party must be delivered to it. Futures contracts differ from options (which are described below) in that they are bilateral agreements, with both the purchaser and the seller equally obligated to complete the transaction. Futures contracts call for settlement only on the expiration date, and cannot be "exercised" at any other time during their term. Options on Futures Contracts. An option on a futures contract gives the purchaser (the "holder") the right, but not the obligation, to enter into a "long" position in the underlying futures contract (i.e., a purchase of such futures contract) in the case of an option to purchase (a "call" option), or a "short" position in the underlying futures contract (i.e., a sale of such futures contract) in the case of an option to sell (a "put" option), at a fixed price (the "strike price") up to a stated expiration date. The holder pays a non-refundable purchase price for the option, known as the "premium". The maximum amount of risk the purchaser of the option assumes is equal to the premium plus related transaction costs, although this entire amount may be lost. Upon exercise of the option by the holder, the exchange clearing corporation establishes a corresponding short position for the seller (the "writer") of the option in the case of a call option, or a corresponding long position in the case of a put option. In the event that an option is exercised, the parties will be subject to all the risks associated with the trading of futures contracts, such as payment of variation margin deposits. In addition, the writer of an option on a futures contract, unlike the holder, is subject to initial and variation margin requirements on the option position. An option, whether based on a futures contract, a stock index or an equity security, becomes worthless to the holder when it expires. A position in an option may be terminated by the purchaser or seller prior to expiration by effecting a closing purchase or sale transaction subject to the availability of a secondary market, which is the purchase or sale of an option of the same series (i.e., the same exercise price and expiration date) as the option previously purchased or sold. The difference between the premiums paid and received represents the party's profit or loss on the transaction. A-1 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD GLOBAL GROWTH FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which Blanchard Global Growth Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page - ----------------- ---- Investment Objective and Policies............................................ 2 Investment Restrictions...................................................... 14 Portfolio Transactions....................................................... 16 Computation of Net Asset Value............................................... 17 Performance Information...................................................... 18 Additional Purchase and Redemption Information............................... 19 Tax Matters.................................................................. 19 The Management of the FUND................................................... 26 Management Services.......................................................... 30 Sector Management Services................................................... 31 Administrative Services...................................................... 32 Distribution Plan............................................................ 32 Description of the FUND...................................................... 33 Shareholder Reports.......................................................... 34 Appendix A...................................................................A-1 Financial Statements.........................................................B-1 Manager Virtus Capital Management, Inc. Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 INVESTMENT OBJECTIVE AND POLICIES The investment objective and policies of the FUND are set forth in the FUND's Prospectus which refers to the following investment strategies and additional information: Options and Futures Strategies Through the writing and purchase of options and the purchase and sale of stock index futures contracts, interest rate futures contracts, foreign currency futures contracts and related options on such futures contracts, Virtus Capital Management, Inc. ("VCM") may at times seek to hedge against a decline in the value of securities included in the FUND's portfolio or an increase in the price of securities which it plans to purchase for the FUND or to reduce risk or volatility while seeking to enhance investment performance. Expenses and losses incurred as a result of such hedging strategies will reduce the FUND's current return. The ability of the FUND to engage in the options and futures strategies described below will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to stock indices, U.S. Government securities and foreign currencies are relatively new and still developing. Although a FUND will not enter into an option or futures position unless a liquid secondary market exists for such option or futures contract is believed by FUND management to exist. There is no assurance that the FUND will be able to effect closing transactions at any particular time or at an acceptable price. Reasons for the absence of a liquid secondary market on an Exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an Exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (iv) unusual or unforeseen circumstances may interrupt normal operations on an Exchange; (v) the facilities of an Exchange or the Options Clearing Corporation ("OCC") may not at all times be adequate to handle current trading volume; or (vi) one or more Exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market thereon would cease to exist, although outstanding options on that Exchange that had been issued by the OCC as a result of trades on that Exchange would continue to be exercisable in accordance with their terms. Low initial margin deposits made upon the opening of a futures position and the writing of an option involve substantial leverage. As a result, relatively small movements in the price of the contract can result in substantial unrealized gains or losses. However, to the extent the FUND purchases or sells futures contracts and options on futures contracts and purchases and writes options on securities and securities indexes for hedging purposes, any losses incurred in connection therewith should, if the hedging strategy is successful, be offset, in whole or in part, by increases in the value of securities held by the FUND or decreases in the prices of securities the FUND intends to acquire. It is impossible to predict the amount of trading interest that may exist in various types of options or futures. Therefore, no assurance can be given that the FUND will be able to utilize these instruments effectively for the purposes stated below. Furthermore, the FUND's ability to engage in options and futures transactions may be limited by tax considerations. Although the FUND will only engage in options and futures transactions for limited purposes, it will involve certain risks which are described in the Prospectus. The FUND will not engage in options and futures transactions for leveraging purposes. Writing Covered Options on Securities The FUND may write covered call options and covered put options on optionable securities (stocks, bonds, foreign exchange, related futures, options and options on futures) of the types in which it is permitted to invest in seeking to attain its objective. Call options written by the FUND give the holder the right to buy the underlying securities from the FUND at a stated exercise price; put options give the holder the right to sell the underlying security to the FUND at a stated price. The FUND may write only covered options, which 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 comparable -2- securities satisfying the cover requirements of securities exchanges). In the case of put options, the FUND will maintain, in a segregated account, cash or short-term U.S. Government securities with a value equal to or greater than the exercise price of the underlying securities or will hold a purchased put option with a higher strike price than the put written. The FUND may also write combinations of covered puts and calls on the same underlying security. The FUND will receive a premium from writing a put or call option, which increases the FUND's return in the event the option expires unexercised or is closed out at a profit. The amount of the premium will reflect, among other things, the relationship of the market price of the underlying security to the exercise price of the option, the term of the option and the volatility of the market price of the underlying security. By writing a call option, the FUND limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By writing a put option, the FUND assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its market value at the time it is exercised resulting in a potential capital loss if the purchase price is greater than the underlying securities current market value minus the amount of the premium received, unless the security subsequently appreciates in value. The FUND may terminate an option that it has written prior to its expiration by entering into a closing purchase transaction in which it purchases an option having the same terms as the option written. The FUND will realize a profit or loss from such transaction if the cost of such transaction is less or more, respectively, than the premium received from the writing of the option. In the case of a put option, any loss so incurred may be partially or entirely offset by the premium received from a simultaneous or subsequent sale of a different put option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from the repurchase of a call option is likely to be offset in whole or in part by unrealized appreciation of the underlying security owned by the FUND. Options written by the FUND will normally have expiration dates not more than one year from the date written. The exercise price of the options may be below ("in-the-money"), equal to ("at-the-money") or above ("out-of-the-money") the current market price of the underlying securities at the times the options are written. The FUND may engage in buy-and-write transactions in which the FUND simultaneously purchases a security and writes a call option thereon. Where a call option is written against a security subsequent to the purchase of that security, the resulting combined position is also referred to as buy-and-write. Buy-and-write transactions using in-the-money call options may be utilized when it is expected that the price of the underlying security will remain flat or decline moderately during the option period. In such a transaction, the FUND's maximum gain will be the premium received from writing the option reduced by any excess of the price paid by the FUND for the underlying security over the exercise price. Buy-and-write transactions using at-the-money call options may be utilized when it is expected that the price of the underlying security will remain flat or advance moderately during the option period. In such a transaction, the FUND's gain will be limited to the premiums received from writing the option. Buy-and-write transactions using out-of-the-money call options may be utilized when it is expected that the premiums received from writing the call option plus the appreciation in market price of the underlying security up to the exercise price will be greater than the appreciation in the price of the underlying security alone. In any of the foregoing situations, if the market price of the underlying security declines, the amount of such decline will be offset wholly or in part by the premium received and the FUND may or may not realize a loss. To the extent that a secondary market is available on the Exchanges, the covered call option writer may liquidate his position prior to the assignment of an exercise notice by entering a closing purchase transaction for an option of the same series as the option previously written. The cost of such a closing purchase, plus transaction costs, may be greater than the premium received upon writing the original option, in which event the writer will have incurred a loss in the transaction. -3- Purchasing Put and Call Options on Securities The FUND may purchase put options to protect its portfolio holdings in an underlying security against a decline in market value. Such hedge protection is provided during the life of the put option since the FUND, as holder of the put option, is able to sell the underlying security at the put exercise price regardless of any decline in the underlying security's market price. In order for a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs. By using put options in this manner, the FUND will reduce any profit it might otherwise have realized in the underlying security by the premium paid for the put option and by transaction costs. The FUND may also purchase call options to hedge against an increase in prices of securities that it wants ultimately to buy. Such hedge protection is provided during the life of the call option since the FUND, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, the FUND will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by transaction costs. Purchase and Sale of Options and Futures on Stock Indices The FUND may purchase and sell options on stock indices and stock index futures as a hedge against movements in the equity markets. Options on stock indices are similar to options on specific securities except that, rather than the right to take or make delivery of the specific security at a specific price, an option on a stock index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of that stock index is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing price of the index and the exercise price of the option expressed in dollars multiplied by a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on specific securities, all settlements of options on stock indices are in cash and gain or loss depends on general movements in the stocks included in the index rather than on price movements in particular stocks. Currently, index options traded include the S&P 100 Index, the S&P 500 Index, the NYSE Composite Index, the AMEX Market Value Index, the National Over-the-Counter Index and other standard broadly based stock market indices. Options are also traded in certain industry or market segment indices such as the Oil Index, the Computer Technology Index and the Transportation Index. A stock index futures contract is an agreement in which one party agrees to deliver to the other an amount of cash equal to a specific dollar amount multiplied by the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made. If the Sector Portfolio Managers (the "Sector Managers") expect general stock market prices to rise, they might purchase a call option on a stock index or a futures contract on that index as a hedge against an increase in prices of particular equity securities they want ultimately to buy. If in fact the stock index does rise, the price of the particular equity securities intended to be purchased may also increase, but that increase would be offset in part by the increase in the value of the FUND's index option or futures contract resulting from the increase in the index. If, on the other hand, the Sector Managers expect general stock market prices to decline, they might purchase a put option or sell a futures contract on the index. If that index does in fact decline, the value of some or all of the equity securities in the FUND's portfolio may also be expected to decline, but that decrease would be offset in part by the increase in the value of the FUND's position in such put option or futures contract. -4- Purchase and Sale of Interest Rate Futures The FUND may purchase and sell U.S. dollar interest rate futures contracts on U.S. Treasury bills, notes and bonds and non-U.S. dollar interest rate futures contracts on foreign bonds for the purpose of hedging fixed income and interest sensitive securities against the adverse effects of anticipated movements in interest rates. The FUND may purchase futures contracts in anticipation of a decline in interest rates when it is not fully invested in a particular market in which it intends to make investments to gain market exposure that may in part or entirely offset an increase in the cost of securities it intends to purchase. The FUND does not consider purchases of futures contracts to be a speculative practice under these circumstances. In a substantial majority of these transactions, the FUND will purchase securities upon termination of the futures contract. The FUND may sell U.S. dollar and non-U.S. dollar interest rate futures contracts in anticipation of an increase in the general level of interest rates. Generally, as interest rates rise, the market value of the fixed income securities held by the FUND will fall, thus reducing the net asset value of the FUND. This interest rate risk can be reduced without employing futures as a hedge by selling long-term fixed income securities and either reinvesting the proceeds in securities with shorter maturities or by holding assets in cash. This strategy, however, entails increased transaction costs to the FUND in the form of dealer spreads and brokerage commissions. The sale of U.S. dollar and non-U.S. dollar interest rate futures contracts provides an alternative means of hedging against rising interest rates. As rates increase, the value of the FUND's short position in the futures contracts will also tend to increase, thus offsetting all or a portion of the depreciation in the market value of the FUND's investments which are being hedged. While the FUND will incur commission expenses in entering and closing out futures positions (which is done by taking an opposite position from the one originally entered into, which operates to terminate the position in the futures contract), commissions on futures transactions are lower than transaction costs incurred in the purchase and sale of portfolio securities. Options on Stock Index Futures Contracts and Interest Rate Futures Contracts The FUND may purchase and write call and put options on stock index and interest rate futures contracts. The FUND may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or stock indices or purchasing and selling the underlying futures. For example, the FUND may purchase put options or write call options on stock index futures or interest rate futures, rather than selling futures contracts, in anticipation of a decline in general stock market prices or rise in interest rates, respectively, or purchase call options or write put options on stock index or interest rate futures, rather than purchasing such futures, to hedge against possible increases in the price of equity securities or debt securities, respectively, which the FUND intends to purchase. Purchase and Sale of Currency Futures Contracts and Related Options In order to hedge its portfolio and to protect it against possible variations in foreign exchange rates pending the settlement of securities transactions, the FUND may buy or sell foreign currencies or may deal in forward currency contracts. The FUND may also invest in currency futures contracts and related options. If a fall in exchange rates for a particular currency is anticipated, the FUND may sell a currency futures contract or a call option thereon or purchase a put option on such futures contract as a hedge. If it is anticipated that exchange rates will rise, the FUND may purchase a currency futures contract or a call option thereon or sell (write) a put option to protect against an increase in the price of securities denominated in a particular currency the FUND intends to purchase. These futures contracts and related options thereon will be used only as a hedge against anticipated currency rate changes, and all options on currency futures written by the FUND will be covered. -5- A currency futures contract sale creates an obligation by the FUND, as seller, to deliver the amount of currency called for in the contract at a specified future time for a specified price. A currency futures contract purchase creates an obligation by the FUND, as purchaser, to take delivery of an amount of currency at a specified future time at a specified price. Although the terms of currency futures contracts specify actual delivery or receipt, in most instances the contracts are closed out before the settlement date without the making or taking of delivery of the currency. Closing out of a currency futures contract is effected by entering into an offsetting purchase or sale transaction. Unlike a currency futures contract, which requires the parties to buy and sell currency on a set date, an option on a currency futures contract entitles its holder to decide on or before a future date whether to enter into such a contract or let the option expire. The FUND will write (sell) only covered put and call options on currency futures. This means that the FUND will provide for its obligations upon exercise of the option by segregating sufficient cash or short-term obligations or by holding an offsetting position in the option or underlying currency future, or a combination of the foregoing. The FUND will, so long as it is obligated as the writer of a call option on currency futures, own on a contract-for-contract basis an equal long position in currency futures with the same delivery date or a call option on stock index futures with the difference, if any, between the market value of the call written and the market value of the call or long currency futures purchased maintained by the FUND in cash, Treasury bills, or other high-grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the call purchased by the FUND falls below 100% of the market value of the call written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high-grade short-term obligations equal in value to the difference. Alternatively, the FUND may cover the call option through segregating with the custodian an amount of the particular foreign currency equal to the amount of foreign currency per futures contract option times the number of options written by the FUND. In the case of put options on currency futures written by the FUND, the FUND will hold the aggregate exercise price in cash, Treasury bills, or other high-grade short-term obligations in a segregated account with its custodian, or own put options on currency futures or short currency futures, with the difference, if any, between the market value of the put written and the market value of the puts purchased or the currency futures sold maintained by the FUND in cash, Treasury bills or other high-grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the put options purchased or the currency futures sold by the FUND falls below 100% of the market value of the put options written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high-grade short-term obligations equal in value to the difference. If other methods of providing appropriate cover are developed, the FUND reserves the right to employ them to the extent consistent with applicable regulatory and exchange requirements. In connection with transactions in stock index options, stock index futures, interest rate futures, foreign currency futures and related options on such futures, the FUND will be required to deposit as "initial margin" an amount of cash and short-term U.S. Government securities generally equal to from 5% to 10% of the contract amount. Thereafter, subsequent payments (referred to as "variation margin") are made to and from the broker to reflect changes in the value of the futures contract. Options on Foreign Currencies The FUND may purchase and write options on foreign currencies to enhance investment performance and for hedging purposes in a manner similar to that in which futures contracts on foreign currencies, or forward contracts, will be utilized as described above. For example, a decline in the dollar value of a foreign currency in which portfolio securities are denominated will reduce the dollar value of such securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of portfolio securities, the FUND may purchase put options on the foreign currency. If the value of the currency does decline, the FUND will have the right to sell such currency for a fixed amount in dollars and will thereby offset, in whole or in part, the adverse effect on its portfolio which otherwise would have resulted. -6- Conversely, where a rise in the dollar value of a currency in which securities to be acquired are denominated is projected, thereby increasing the cost of such securities, the FUND may purchase call options thereon. The purchase of such options could offset, at least partially, the effects of the adverse movements in exchange rates. As in the case of other types of options, however, the benefit to the FUND deriving from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, where currency exchange rates do not move in the direction or to the extent anticipated, the FUND could sustain losses on transactions in foreign currency options which would require it to forego a portion or all of the benefits of advantageous changes in such rates. Also, where the FUND anticipates a decline in the dollar value of foreign currency denominated securities due to adverse fluctuations in exchange rates it could, instead of purchasing a put option, write a call option on the relevant currency. If the expected decline occurs, the option will most likely not be exercised, and the diminution in value of portfolio securities will be offset by the amount of the premium received. Similarly, instead of purchasing a call option to hedge against an anticipated increase in the dollar cost of securities to be acquired, the FUND could write a put option on the relevant currency which, if the currency moves in the manner projected, will expire unexercised and allow the FUND to hedge such increased cost up to the amount of the premium. As in the case of other types of options, however, the writing of a foreign currency option will constitute only a partial hedge up to the amount of the premium, and only if rates move in the expected direction. If this does not occur, the option may be exercised and the FUND would be required to purchase or sell the underlying currency at a loss which may not be offset by the amount of the premium. Through the writing of options on foreign currencies, the FUND also may be required to forego all or a portion of the benefits which might otherwise have been obtained from favorable movements in exchange rates. The FUND intends to write covered call options on foreign currencies. A call option written on a foreign currency by the FUND is "covered" if the FUND owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian, which acts as the FUND's custodian, or by a designated sub-custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the FUND has a call on the same foreign currency and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price or the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the FUND in cash, U.S. Government Securities and other high-grade liquid debt securities in a segregated account with its custodian or with a designated sub-custodian. Mortgage and Asset-Backed Securities Subject to the approval of the Board of Trustees of the FUND, the FUND may invest in foreign mortgage-backed and asset-backed securities. The FUND will only purchase mortgage-backed and asset-backed securities which, in its opinion, equate generally to U.S. standards of "investment grade" obligations. Mortgage-backed securities are securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property, including pass-through securities and collateralized mortgage obligations. The yield and credit characteristics of mortgage-backed securities differ in a number of respects from traditional debt securities. Asset-backed securities have similar structural characteristics to mortgage-backed securities. However, the underlying assets are not mortgage loans or interests in mortgage loans but include assets such as motor vehicle installment sales or installment loan contracts, leases of various types of real and personal property, and receivables from revolving credit (credit card) agreement. -7- Repurchase Agreements Repurchase agreements are transactions by which the FUND purchases a security and simultaneously commits to resell that security to the seller at an agreed upon price on an agreed upon date within a number of days (usually not more than seven days) from the date of purchase. The resale price reflects the purchase price plus an agreed upon market rate of interest which is unrelated to the coupon rate or maturity of the purchased security. A repurchase agreement involves the obligation of the seller to pay the agreed upon price, which obligation is in effect secured by the value (at least equal to the amount of the agreed upon resale price and marked-to-market daily) of the underlying security. While it does not presently appear possible to eliminate all risks from these transactions (particularly the possibility of a decline in the market value of the underlying securities, as well as delay and costs to the FUND in connection with bankruptcy proceedings) it is the policy of the FUND to limit repurchase agreements to those member banks of the Federal Reserve System and primary dealers in U.S. Government securities who are believed by the FUND's Trustees to present minimum credit risk. Repurchase agreements maturing in more than seven days are considered, for the purposes of the FUND's investment restrictions, to be illiquid securities. No more than 10% of the FUND's net assets may be held in illiquid securities (see "Investment Restrictions"). Forward Foreign Currency Exchange Contracts The value of the assets of the Foreign Securities, Precious Metals Securities and Bullion, Emerging Markets and Foreign Fixed Income Securities investment sectors of the FUND as measured in U.S. dollars may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the FUND may incur costs in connection with conversions between various currencies. The FUND may purchase or sell forward foreign currency exchange contracts ("forward contracts") to attempt to minimize the risk to the FUND from adverse changes in the relationship between the U.S. dollar and foreign currencies. A forward contract is an obligation to purchase or sell a specific currency for an agreed price at a future date which is individually negotiated and privately traded by currency traders and their customers. The FUND may enter into a forward contract, for example, when it enters into a contract for the purchase or sale of a security denominated in a foreign currency in order to "lock in" the U.S. dollar price of the security ("transaction hedge"). Additionally, for example, when the FUND believes that a foreign currency may suffer a substantial decline against the U.S. dollar, it may enter into a forward sale contract to sell an amount of that foreign currency approximating the value of some or all of the FUND's securities denominated in such foreign currency, or when the FUND believes that the U.S. dollar may suffer a substantial decline against foreign currency, it may enter into a forward purchase contract to buy that foreign currency for a fixed dollar amount ("position hedge"). In this situation, the FUND may, in the alternative, enter into a forward contract to sell a different foreign currency for a fixed U.S. dollar amount where it believes that the U.S. dollar value of the currency to be sold pursuant to the forward contract will fall whenever there is a decline in the U.S. dollar value of the currency in which portfolio securities of the sector are denominated ("cross-hedge"). If the FUND enters into a position hedging transaction, cash not available for investment or U.S. Government Securities or other high quality debt securities will be placed in a segregated account in an amount sufficient to cover the FUND's net liability under such hedging transactions. If the value of the securities placed in the segregated account declines, additional cash or securities will be placed in the account so that the value of the account will equal the amount of the FUND's commitment with respect to its position hedging transactions. As an alternative to maintaining all or part of the separate account, the FUND may purchase a call option permitting it to purchase the amount of foreign currency being hedged by a forward sale contract at a price no higher than the forward contract price or the FUND may purchase a put option permitting it to sell the amount of foreign currency subject to a forward purchase contract at a price as high or higher than the forward contract price. Unanticipated changes in currency prices would result in lower overall performance for the FUND than if it had not entered into such contracts. While the pursuit of foreign currency gain is not a primary objective of the FUND, the FUND may, from time to time, hold foreign currency to realize such gains. (These gains constitute non-qualifying income that is subject to the 10% limitation with respect to the "Income Requirements" of Subchapter M of the -8- Internal Revenue Code of 1986, as amended, which is discussed herein under "Dividends, Capital Gains Distributions and Tax Matters".) The FUND will enter into forward foreign currency exchange contracts as described hereafter. When the FUND enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to establish the U.S. dollar cost or proceeds. By entering into a forward contract in U.S. dollars for the purchase or sale of the amount of foreign currency involved in an underlying security transaction, the FUND will be able to protect itself against a possible loss between trade and settlement dates resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. However, this tends to limit potential gains which might result from a positive change in such currency relationships. When one of the Sector Managers believes that the currency of a particular foreign country may suffer a substantial decline against the U.S. dollar, it may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of the FUND's portfolio securities denominated in such foreign currency. The forecasting of short-term currency market movement is extremely difficult and the successful execution of a short-term hedging strategy is highly uncertain. Under normal circumstances, consideration of the prospect for currency parities will be incorporated into the longer term investment decisions made with regard to overall strategies. However, the Trustees of the FUND believe that it is important to have the flexibility to enter into such forward contracts when the Sector Managers determine that the best interests of the FUND will be served. Generally, the FUND will not enter into a forward foreign currency exchange contract with a term of greater than one year. At the maturity of the contract, the FUND may either sell the portfolio security and make delivery of the foreign currency, or may retain the security and terminate the obligation to deliver the foreign currency by purchasing an "offsetting" forward contract with the same currency trader obligating the FUND to purchase, on the same maturity date, the same amount of foreign currency. It is impossible to forecast with absolute precision the market value of portfolio securities at the expiration of the contract. Accordingly, it may be necessary for the FUND to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security is less than the amount of foreign currency the FUND is obligated to deliver and if a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security if its market value exceeds the amount of foreign currency the FUND is obligated to deliver. If the FUND retains the portfolio security and engages in an offsetting transaction, the FUND will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the FUND engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline during the period between entering into a forward contract for the sale of a foreign currency and the date the FUND enters into an offsetting contract for the purchase of the foreign currency, the FUND will realize a gain to the extent the price of the currency the FUND has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the FUND will suffer a loss to the extent the price of the currency the FUND has agreed to purchase exceeds the price of the currency the FUND has agreed to sell. The FUND's dealing in forward foreign currency exchange contracts will be limited to the transactions described above. Of course, the FUND is not required to enter into such transactions with regard to its foreign currency-denominated securities and will not do so unless deemed appropriate by the Sector Managers. It also should be realized that this method of protecting the value of the FUND's portfolio securities against the decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange which one can achieve at some future point in time. Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time they tend to limit any potential gain which might result should the value of such currency increase. -9- Additional Risks of Futures Contracts and Related Options, Forward Foreign Currency Exchange Contracts and Options on Foreign Currencies The market prices of futures contracts may be affected by certain factors. First, all participants in the futures market are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the securities and futures markets. Second, from the point of view of speculators, the deposit requirements in the futures market are less onerous than margin requirements in the securities market. Therefore, increased participation by speculators in the futures market may also cause temporary price distortions. In addition, futures contracts in which the FUND may invest may be subject to commodity exchange imposed limitations on fluctuations in futures contract prices during a single day. Such regulations are referred to as "daily price fluctuation limits" or "daily limits." During a single trading day no trades may be executed at prices beyond the daily limit. Once the price of a futures contract has increased or decreased by an amount equal to the daily limit, positions in those futures cannot be taken or liquidated unless both a buyer and seller are willing to effect trades at or within the limit. Daily limits, or regulatory intervention in the commodity markets, could prevent the FUND from promptly liquidating unfavorable positions and adversely affect operations and profitability. Options on foreign currencies and forward foreign currency exchange contracts ("forward contracts") are not traded on contract markets regulated by the Commodity Futures Trading Commission ("CFTC") and are not regulated by the SEC. Rather, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to SEC regulation. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the SEC, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the OCC, thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the FUND to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, futures contracts and related options and forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in -10- the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by the FUND over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. During the coming year, the FUND may invest up to 10% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering". Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The Commission has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) the nature of the security and the nature of the -11- marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). Regulatory Matters In connection with its proposed futures and options transactions, the FUND has filed with the Commodity Futures Trading commission ("CFTC") a notice of eligibility for exemption from the definition of (and therefore from CFTC regulation as) a "commodity pool operator" under the Commodity Exchange Act. The FUND has represented in its notice of eligibility that: (i) it will not purchase or sell futures or options on futures contracts or stock indices if as a result the sum of the initial margin deposits on its existing futures contracts and related options positions and premiums paid for options on futures contracts or stock indices would exceed 5% of the FUND's assets; and (ii) with respect to each futures contract purchased or long position in an option contract, the FUND will set aside in a segregated account cash or cash equivalents in an amount equal to the market value of such contracts less the initial margin deposit. The Staff of Securities and Exchange Commission ("Commission") has taken the position that the purchase and sale of futures contracts and the writing of related options may involve senior securities for the purposes of the restrictions contained in Section 18 of the Investment Company Act of 1940 on investment companies issuing senior securities. However, the Staff has issued letters declaring that it will not recommend enforcement action under Section 18 if an investment company: (i) sells futures contracts to offset expected declines in the value of the investment company's portfolio securities, provided the value of such futures contracts does not exceed the total market value of those securities (plus such additional amount as may be necessary because of differences in the volatility factor of the portfolio securities vis a vis the futures contracts); (ii) writes call options on futures contracts, stock indexes or other securities, provided that such options are covered by the investment company's holding of a corresponding long futures position, by its ownership of portfolio securities which correlate with the underlying stock index, or otherwise; (iii) purchases futures contracts, provided the investment company establishes a segregated account ("cash segregated account") consisting of cash or cash equivalents in an amount equal to the total market value of such futures contracts less the initial margin deposited therefor; and (iv) writes put options on futures contracts, stock indices or other securities, provided that such options are covered by the investment company's holding of a corresponding short futures position, by establishing a cash segregated account in an amount equal to the value of its obligation under the option, or otherwise. The FUND will conduct its purchases and sales of futures contracts and writing of related options transactions in accordance with the foregoing. -12- Additional Information Regarding Precious Metals and Precious Metals Securities The production and marketing of gold and precious metals may be affected by the action of certain governments and changes in existing governments. For example, the mining of gold is highly concentrated in a few countries. In current order of magnitude of production of gold bullion, the five largest producers of gold are the Republic of South Africa, certain republics of the former Soviet Union, Canada, Brazil and the United States. Economic and political conditions prevailing in these countries may have a direct effect on the production and marketing of newly produced gold and sales of central bank gold holdings. It is expected that a majority of gold mining companies in which the FUND will invest will be located within the United States and Canada. Prices of Precious Metals Securities can be volatile and tend to experience greater volatility than the prices of physical precious metals. This is due to the fact that the costs of mining precious metals remain relatively fixed, so that an increase or decrease in the price of precious metals has a direct and greater than proportional effect on the profitability of precious metals mining companies. Investments tied to precious metals characteristically involve high risk because of precious metals' price volatility. The price of precious metals is affected by factors such as cyclical economic conditions, political events and monetary policies of various countries. During periods of rising precious metals prices, the Fund will tend to emphasize investments in Precious Metals Securities. Under South African law, the only authorized sales agent for gold produced in South Africa is the Reserve Bank of South Africa, which through its retention policies controls the time and place of any sale of South African bullion. The South African Ministry of Mines determines gold mining policy. South Africa depends predominantly on gold sales for the foreign exchange necessary to finance its imports, and its sales policy is necessarily subject to national economic and political developments. Investments in Emerging Countries The Emerging Markets sector of the FUND may invest indirectly in securities of emerging country issuers through sponsored or unsponsored American Depository Receipts ("ADRs"), Global Depository Receipts ("GDRs") and other types of Depository Receipts (which, together with ADRs and GDRs, are hereinafter referred to as "Depository Receipts"). Depository Receipts may not necessarily be denominated in the same currency as the underlying securities into which they may be converted. In addition, the issuers of the stock of unsponsored Depository Receipts are not obligated to disclose material information in the United States and, therefore, there may not be a correlation between such information and the market value of the Depository Receipts. Investing in emerging country securities involves certain considerations not typically associated with investing in securities of U.S. companies, including (1) restrictions on foreign investment and on repatriation of capital invested in emerging countries, (2) currency fluctuations, (3) the cost of converting -13- foreign currency into U.S. dollars, (4) potential price volatility and lesser liquidity of shares traded on emerging country securities markets and (5) political and economic risks, including the risk of nationalization or expropriation of assets and the risk of war. In addition, accounting, auditing, financial and other reporting standards in emerging countries are not equivalent to U.S. standards and, therefore, disclosure of certain material information may not be made and less information may be available to investors investing in emerging countries than in the United States. There is also generally less governmental regulation of the securities industry in emerging countries than in the United States. Moreover, it may be more difficult to obtain a judgment in a court outside the United States. Interest and dividends paid on securities held by the FUND and gains from the disposition of such securities may be subject to withholding taxes imposed by emerging market countries. Historical experience indicates that the markets of developing countries have been more volatile than the markets of developed countries; however, securities traded in such markets often have provided higher rates of return to investors. VCM believes that these characteristics may be expected to continue in the future. Portfolio Turnover Generally, the FUND's portfolio turnover rate is not expected to exceed 100%. A 100% portfolio turnover rate would occur if 100% of the securities owned by the FUND were sold and either repurchased or replaced by it within one year. However, the Fund may experience a temporary increase in portfolio turnover and incur some additional transaction costs as a result of the restructuring approved by the Fund's shareholders on January 15, 1992 as the new portfolio managers invest Fund assets transferred to their management. The FUND's portfolio turnover rate is, generally, the percentage computed by dividing the lesser of FUND's purchases or sales exclusive of short-term securities and bullion, by the average value of the FUND's total investments exclusive of short-term securities and bullion. The portfolio turnover rates for the fiscal years ended April 30, 1995 and 1994 were 221% and 166%, respectively. The Fund's portfolio's turnover rate for the fiscal years ended April 30, 1995 and 1994 was higher than normal due to volatile foreign markets. High portfolio turnover involves correspondingly greater brokerage commissions, other transaction costs, and a possible increase in short-term capital gains or losses. Shareholders are taxed on any such net gains at ordinary income rates. Because any capital gains realized would be distributed to shareholders at year-end, shareholders should consider the impact of such distributions on their own tax position. INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the Investment Company Act of 1940, as amended) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. As a non-diversified management investment company, the FUND has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within -14- any one industry as such industries are defined in the SIC/SEC Industries Code; or (d) more than 5% of total assets would be invested in warrants or rights. 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 10% of the market value of its total assets). The FUND will not purchase additional securities while borrowing is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities other than (a) through the purchase of publicly distributed debt securities in accordance with its investment objective and (b) through repurchase agreements. 5. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities. 6. The FUND may not knowingly purchase or otherwise acquire securities which are subject to legal or contractual restrictions on resale or for which there is no readily available market if, as a result thereof, more than 10% of the net assets of the FUND (taken at market value) would be invested in such securities, including repurchase agreements in excess of 7 days. 7. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 8. The FUND may not purchase or sell commodity contracts, except to the extent that forward foreign currency exchange contracts are deemed to be commodity contracts. (See "Investment Objective and Policies - Forward Foreign Currency Exchange Contracts"). 9. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 10. The FUND may not invest in companies for the purpose of exercising control or management. 11. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 12. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 13. The FUND may not purchase or sell real estate (although it may purchase securities secured by real estate interests or interests therein, or issued by companies or investment trusts which invest in real estate or interests therein). 14. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs; provided, however, that if consistent with the objective of the FUND, the FUND may purchase securities of issuers whose principal business activities fall within such areas. 15. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment -15- by terminating sales of its shares in the state(s) involved. Pursuant to one such commitment, the Trust has agreed that the FUND will not: (1) invest in warrants, valued at the lower of cost or market, in excess of 5% of the value of the FUND's net assets, and no more than 2% of such value may be warrants which are not listed on the New York or American Stock Exchanges; and (2) make direct investments in oil, gas or other mineral leases. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by each of the Sector Portfolio Managers subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract and Sub-Advisory Agreement between the FUND and VCM and VCM and the Sector Managers. In selecting such brokers or dealers, the Sector Managers will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to the Sector Managers for the FUND's use. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to the Sector Managers. Such allocation shall be in such amounts as VCM shall determine and the Sector Managers shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The Trustees must determine that such services are reasonable and necessary to the FUND's normal operations. The receipt of research from broker-dealers may be useful to the Sector Managers in rendering investment management services to their other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of the Sector Managers' other clients may be useful to the Sector Managers in carrying out their obligations to the FUND. The receipt of such research may not reduce the Sector Managers' normal independent research activities. The Sector Managers are authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and the Sector Managers or their affiliated broker-dealers on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from brokerage commissions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the advisory fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreements between VCM and the Sector Managers do not provide for any reduction in the advisory fees as a result of profits resulting from brokerage commissions effected through the Sector Managers or their affiliated brokerage firms. The Trustees had adopted certain procedures incorporating the standards of Rule 17e-1 issued under the Investment Company Act of 1940 (the "1940 Act") which requires that the commissions paid the Distributor or to the Sector Managers or their affiliated broker-dealers must be "reasonable and fair compared to -16- the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. For the years ended April 30, 1995, 1994 and 1993, the FUND incurred brokerage commission expenses of $488,175, $583,706 and $394,285, respectively, from the purchase and sale of portfolio securities, of which $173,599, $121,292 and $164,340, respectively, or approximately 36%, 21% and 42%, respectively, was paid to Shufro, Rose & Ehrman, a Sector Manager of the FUND, for effecting 46%, 27% and 24%, respectively, of the FUND's aggregate dollar amount of transactions involving the payment of commissions. Shufro, Rose & Ehrman operates under standards which would allow it to receive no more than the remuneration which would be expected to be received by an unaffiliated broker in a commensurate arms-length transaction which is executed on the New York or American Stock Exchanges. Moreover, in effecting portfolio transactions through Shufro, Rose & Ehrman, the cost of the brokerage commissions to the FUND in some cases is less than that available from unaffiliated brokers. The reliability of Shufro, Rose & Ehrman and the value of its expected contribution to the FUND, viewed either in terms of a particular transaction or the portfolio manager's overall responsibilities to the FUND, is also taken into consideration in selecting Shufro, Rose & Ehrman to serve as the FUND's broker. In addition, of the aggregate brokerage commissions incurred for the year ended April 30, 1993) (which represents approximately 5% of total commissions paid in 1993 was also paid to Morgan Stanley Asset Management Limited, a former Sector Manager of the FUND. It may happen that the same security will be held by other clients of VCM or of the portfolio managers. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The net asset value per share is computed by dividing the value of all securities plus other assets, less liabilities, by the number of shares outstanding. Each determination of the FUND's net asset value is made (i) by valuing portfolio securities which are traded on the New York Stock Exchange or the American Stock Exchange at the last sale price, or, if no sale, at the closing bid price, (ii) by valuing other securities as nearly as possible in the manner described in clause (i) if traded on any other U.S. or foreign exchange, and, if not so traded, on the basis of the latest available bid prices. A security which is listed or traded on more than one exchange, is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or VCM. High-quality short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less, or by amortizing their value on the 61st day prior to maturity if their original term to maturity exceeded 60 days. Amortized cost will be used unless the Board of Trustees determines that such method does not represent fair value. -17- Generally, trading in foreign securities, as well as trading in corporate bonds, U.S. government securities, money market instruments and repurchase agreements, is substantially completed each day at various times prior to the close of the New York Stock Exchange. The values of such securities used in computing the net asset value of the FUND are determined as of such times. Foreign currency exchange rates are also generally determined prior to 4:15 p.m. Bullion investments are valued at the closing spot price based on dealer or exchange quotations. Occasionally, events affecting the value of metal securities may occur between such times and 4:15 p.m. which will not be reflected in the computation of the FUND's net asset value. If events occur which materially affect the value of metal securities, the securities will be valued at fair value as determined in good faith by the Trustees. Puts and calls held by the FUND are valued at the last sales price or, if there are no transactions, at the mean between the closing bid and asked prices. When the FUND writes a call, an amount equal to the premium received is included in the FUND's statement of assets and liabilities as an asset, and an equivalent credit is included in the liability section. The credit is "marked-to-market" to reflect the current market value of the call. If a call expires, the FUND has a gain in the amount of the premium received; if the FUND enters into a closing purchase transaction, it will have a gain or loss depending on whether the premium received was more or less than the cost of the closing transaction. All other securities and other assets of the FUND are valued at fair value as determined in good faith by the Trustees. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated in terms of total return, rather than in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the SEC, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. -18- The FUND's average annual total rate of return figures, reflecting the initial investment of $1,000 and reinvestment of all dividends and distributions, net of the pro rata share of the account opening fee, for the one and five year periods ended April 30, 1995 and for the period from June 1, 1986 (commencement of operations) to April 30, 1995, were -1.04%, 5.67% and 7.59%, respectively. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or the Standard & Poor's 500 Stock Index or the Dow Jones Industrial Average, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect until December, 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under SEC rules and all advertisements containing performance data will include a legend disclosing that such performance data represent past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as a shareholder of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends -19- and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Code Section 1256 (unless the FUND elects otherwise), will generally be treated as ordinary income or loss. -20- In general, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The FUND, however, may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service (the "IRS") has held in several private rulings (and Treasury Regulations now provide) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The FUND may purchase securities of certain foreign investment funds or trusts which constitute passive foreign investment companies ("PFICs") for federal income tax purposes. If the FUND invests in a PFIC, it may elect to treat the PFIC as a qualifying electing fund (a "QEF") in which event the FUND will each year have ordinary income equal to its pro rata share of the PFIC's ordinary earnings for the year and long-term capital gain equal to its pro rata share of the PFIC's net capital gain for the year, regardless of whether the FUND receives distributions of any such ordinary earning or capital gain from the PFIC. If the FUND does not (because it is unable to, chooses not to or otherwise) elect to treat the PFIC as a QEF, then in general (i) any gain recognized by the FUND upon sale or other disposition of its interest in the PFIC or any "excess distribution" (as defined) received by the FUND from the PFIC will be allocated ratably over the FUND's holding period of its interest in the PFIC, (ii) the portion of such gain or excess distribution so allocated to the year in which the gain is recognized or the excess distribution is received shall be included in the FUND's gross income for such year as ordinary income (and the distribution of such portion by the FUND to shareholders will be taxable as an ordinary income dividend, but such portion will not be subject to tax at the FUND level), (iii) the FUND shall be liable for tax on the portions of such gain or excess distribution so allocated to prior years in an amount equal to, for each such prior year, (A) the amount of gain or excess distribution allocated to such prior year multiplied by the highest corporate -21- tax rate in effect for such prior year plus (B) interest on the amount determined under clause (A) for the period from the due date for filing a return for such prior year until the date for filing a return for the year in which the gain is recognized or the excess distribution is received at the rates and methods applicable to underpayments of tax for such period, and (iv) the distribution by the FUND to shareholders of the portions of such gain or excess distribution so allocated to prior years (net of the tax payable by the FUND thereon) will again be taxable to the shareholders as an ordinary income dividend. Under recently proposed Treasury Regulations the FUND can elect to recognize as gain the excess, as of the last day of its taxable year, of the fair market value of each share of PFIC stock over the FUND's adjusted tax basis in that share ("mark to market gain"). Such mark to market gain will be included by the FUND as ordinary income, such gain will not be subject to the Short-Short Gain Test, and the FUND's holding period with respect to such PFIC stock commences on the first day of the next taxable year. If the FUND makes such election in the first taxable year it holds PFIC stock, the FUND will include ordinary income from any mark to market gain, if any, and will not incur the tax described in the previous paragraph. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. As of April 30, 1995, the FUND elected to defer such foreign currency losses of approximately $409,601 to the succeeding year. At April 30, 1995 the Fund had a net capital loss carryover of $293,056, which is available through April 30, 2003 to offset future capital gains. In addition to satisfying the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. However, with regard to forward currency contracts, there does not appear to be any formal or informal authority which identifies the issuer of such instrument. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall: (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year; -22- and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they will qualify for the 70% dividends-received deduction for corporate shareholders only to the extent discussed below. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain is distributed and designated as a capital gain dividend, will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. The Code provides, however, that under certain conditions only 50% of the capital gain recognized upon the FUND's disposition of "small business" stock will be subject to tax. Ordinary income dividends paid by the FUND with respect to a taxable year will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as S corporations, which are not eligible for the deduction because of their special characteristics and other than for purposes of special taxes such as the accumulated earnings tax and the personal holding company tax) to the extent of the amount of qualifying dividends received by the FUND from domestic corporations for the taxable year. A dividend received by the FUND will not be treated as a qualifying dividend (1) if it has been received with respect to any share of stock that the FUND has held for less than 46 days (91 days in the case of certain preferred stock), excluding for this purpose under the rules of Code Section 246(c) (3) and (4): (i) any day more than 45 days (or 90 days in the case of certain preferred stock) after the date on which the stock becomes ex-dividend and (ii) any period during which the FUND has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such (or substantially identical) stock; (2) to the extent that the FUND is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property; or (3) to the extent the stock on which the dividend is paid is treated as debt-financed under the rules of Code Section 246A. Moreover, the dividends-received deduction for a corporate shareholder may be disallowed or reduced (i) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the FUND or (ii) by application of Code Section 246(b) which in general limits the dividends-received deduction to 70% of the shareholder's taxable income (determined without regard to the dividends-received deduction and certain other items). -23- Alternative minimum tax ("AMT") is imposed in addition to, but only to the extent it exceeds, the regular tax and is computed at a maximum marginal rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. For purposes of the corporate AMT and the environmental super fund tax (which are discussed above), the corporate dividends-received deduction is not itself an item of tax preference that must be added back to taxable income or is otherwise disallowed in determining a corporation's AMTI. However, corporate shareholders will generally be required to take the full amount of any dividend received from the FUND into account (without a dividends-received deduction) in determining its adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consist of the stock or securities of foreign corporations, the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid his pro rate share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any -24- shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (discussed above in connection with the dividends-received deduction for corporations) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate, if any) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate, if any) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends . If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and any gains realized upon the sale of shares of the FUND will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. -25- Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc., Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties
-26- Corporation; Senior Vice-President, John R. Wood and Asociates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region.
-27- Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Treasurer and Trustee of the Fund; President, Treasurer and Director of Blanchard Precious Metals Fund, Inc. and The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds.
-28- Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. -29- Fund Ownership As of July 30, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 30, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Truste $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trust $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee -30- Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds. MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the fiscal years ended April 30, 1995, 1994 and 1993, aggregate amount paid or accrued by the FUND to the prior manager was $983,753, $943,678 and $1,038,443, respectively. SECTOR MANAGEMENT SERVICES Pursuant to sub-advisory agreements (the "Sub-Advisory Agreements") between VCM and the Sector Managers, VCM has delegated to the Sector Managers the authority and responsibility to make and execute decisions for the FUND within the framework of the FUND's investment policies, subject to review by VCM and the Board of Trustees of the FUND. Under the terms of the Sub-Advisory Agreements, the Sector Managers have discretion to purchase and sell securities, except as limited by the FUND's investment objective, policies and restrictions. The Sub-Advisory Agreements provide for the payment to the Sector Managers, by VCM, of monthly compensation based on each Sector's average daily net assets for providing investment advice to the FUND and managing the investment of the assets of the FUND. For the services provided by the Sector Managers pursuant to the Sub-Advisory Agreements, VCM (not the FUND) will pay each Sector Manager an annual sub-advisory fee equal to the greater of $25,000 per annum, or the following percentages of the Sector's average daily net assets: -31- Net Assets Exceeding Net Assets $150 million Net Assets Up to $150 but less than Exceeding million $300 million $300 million ---------- ------------- ------------ Shufro, Rose & Ehrman (U.S. Equities) .30% .2625% .225% Fiduciary International, Inc. (Foreign Equities) .45 .39375 .3375 Cavelti Capital Management, Ltd. (Precious Metals Securities and Bullion) .30 .2625 .225 > Investment Advisers, Inc. (American Fixed Income) .20 .175 .15 Martin Currie, Inc. (Emerging Markets) .50 .4375 .375 Fiduciary International, Inc. (Foreign Fixed Income) .375 .32825 .28125 For the fiscal years ended April 30, 1995, 1994 and 1993, the aggregate amounts paid by the prior manager to each Sector Manager (former Sector Manager) under the Sub-Advisory Agreements were as follows: Shufro Rose & Ehrman - $90,508, $104,023 and $108,149; Investment Advisers, Inc. - $22,423, $5,641 and $64,581, respectively; Cavelti Capital Management, Inc. - $23,596, $10,558 and $1,484, respectively; Morgan Stanley Asset Management Limited (replaced by Fiduciary International, Inc.) - $63,586 and $165,781, respectively; Fiduciary International, Inc. - $108,636, $91,814 and $18,831, and Morgan Stanley Asset Management Inc. (replaced by Martin Currie Inc.) - $55,912 and $3,636 (for the fiscal periods ended April 30, 1993 and 1992). Each Sub-Advisory Agreement provides that the Sector Manager's fee shall be reduced proportionately based on the ratio of the Sector Manager's fee to VCM's fee in the event VCM's fee is reduced as a result of a state expense limitation. The Sub-Advisory Agreements, dated July 11, 1995, were approved by the FUND's then Trustees on March 24, 1995 and the FUND's shareholders on July 11, 1995. Each Sub-Advisory Agreement provides that it may be terminated without penalty by either the FUND or the Sector Manager at any time by the giving of 60 days' written notice to the other and terminates automatically in the event of "assignment", as defined in the Investment Company Act. Each Sub-Advisory Agreement provides that, unless sooner terminated, it shall continue in effect for an initial two year period and from year to year thereafter only so long as such continuance is specifically approved at least annually by either the Board of Trustees of the FUND or by a vote of the majority of the outstanding voting securities of the FUND, provided, that in either event, such continuance is also approved by the vote of the majority of the Trustees who are not parties to the Sub-Advisory Agreement or "interested persons" of such parties cast in person at a meeting called for the purpose of voting on such approval. -32- Global Allocation Strategist Pursuant to the terms of the Global Allocation Agreement between it and the FUND dated July 11, 1995, the Global Allocation Strategist reviews, evaluates and allocates the percentages in which the total assets of the FUND will be divided among its investment sectors, subject at all times to the direction of VCM and the policies and control of the FUND's Board of Trustees. In discharging its responsibilities under the agreement, the Global Allocation Strategist (i) obtains and evaluates pertinent information about significant developments and economics, statistical and financial data, domestic, foreign or otherwise, whether affecting the economy generally or the FUND's portfolio; (ii) formulates and implements continuing programs for the review, evaluation and allocation of the FUND's assets and regularly reports thereon to the FUND's Board of Trustees; and (iii) takes, on behalf of the FUND, all actions which appear to the Trust and VCM necessary to carry into effect such programs and supervisory functions. As compensation for its services, the Global Allocation Strategist is paid a monthly fee by VCM (not the FUND) at the annual rate of .08% of the FUND"s first $150 million of average daily net assets; plus .07% of the FUND's average daily net assets in excess of $150 million but less than $300 million; plus .06% of the FUND's average daily net assets in excess of $300 million. The Global Allocation Agreement provides that, unless sooner terminated, it shall continue in effect for an initial two year period and from year to year thereafter only so long as such continuance is specifically approved at least annually by either the Board of Trustees of the FUND or by a vote of the majority of the outstanding voting securities of the FUND, provided, that in either event, such continuance is also approved by the vote of the majority of the Trustees who are not parties to the Sub-Advisory Agreement or "interested persons" of such parties cast in person at a meeting called for the purpose of voting on such approval. For the fiscal years ended April 30, 1995, 1994 and 1993, the prior manager paid the FUND's Global Allocation Strategist $78,701, $75,352 and $83,114 respectively. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the Fund accrued payments under the Plan amounting to $704,436. -33- Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. -34- SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. FINANCIAL STATEMENTS Audited financial statements of the Fund for the fiscal year ended April 30, 1995 are attached hereto. -35- APPENDIX A Description of Moody's Investors Service, Inc.'s Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *Aaa: Bonds which are rated Aaa are judged to be 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 fluctuations 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: Bond which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. *Baa: Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba: Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during other good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C: Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating classification from Aa through B in its bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category, the modifier 2 indicates a mid-range ranking, and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. A-1 Description of Moody's Commercial Paper Ratings: Moody's commercial paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Issuers rated Prime-1 or P-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 or P-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. Issuers rated Prime-2 or P-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 alternate liquidity is maintained. Description of Standard & Poor's Corporation's Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *AAA: Debt rated AAA have the highest rating assigned by S&P to a debt obligation. capacity to pay interest and repay principal is extremely strong. *AA: Debt rated AA have a very strong capacity to pay interest; and repay principal and differ from the higher rated issues only in small degree. *A: Debt rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. *BBB: Debt rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds in higher rated categories. BB, B, CCC, CC, C: Debt rated "BB," "B," "CCC," "CC" and "C" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "C" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. A-2 BB: Debt rated "BB" has less near-term vulnerability to default than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. The "BB" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BBB-" rating. B: Debt rated "B" has a greater vulnerability to default but currently has the capacity to meet interest payments and principal repayments. Adverse business, financial or economic conditions will likely impair capacity or willingness to pay interest and repay principal. The "B" Rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BB" or "BB-" rating. CCC: Debt rated "CCC" has a currently identifiable vulnerability to default, and is dependent upon favorable business, financial, and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal. The "C" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "B" or "B-" rating. CC: The rating "CC" is typically applied to debt subordinated to senior debt that is assigned an actual or implied "CCC" rating. C: The rating "C" is typically applied to debt subordinated to senior debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating may be used to cover a situation where a bankruptcy petition has been filed, but debt service payments are continued. C1: The rating "C1" is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in payment default. The "D" rating category is used when interest payments or principal or principal payments are not made on the date due even if the applicable grace period has not expired, unless S&P believes that such payments will be made during such grace period. The "D" rating also will be used upon the filing of a bankruptcy petition if debt service payments are jeopardized. Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. NR: Bonds may lack a S&P rating because no public rating has been requested, because there is insufficient information on which to base a rating, or because S&P does not rate a particular type of obligation as a matter of policy. Description of S&P's Commercial Paper Ratings: S&P's commercial paper ratings are current assessments of the likelihood of timely payment of debts having an original maturity of no more than 365 days. A: Issues assigned this highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-1: This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelming safety characteristics are denoted with a plus (+) sign designation. A-2: Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1". A-3 A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. A-4 Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Global Growth Fund for the fiscal year ending April 30, 1995. As a global asset allocation manager, we can almost always find some market in the world that is acting well. In 1994, as a result of an increasingly globalized economy, this was not the case, as almost all worldwide markets were in a state of flux. As the fiscal year progressed, we made a defensive allocation to cash, so that in the third quarter of 1994 we held 30% of the Fund's portfolio in cash while waiting for markets to calm and for opportunities to appear. We saw such an opportunity materialize early in 1995 and, in February and March, redeployed much of our cash into the U.S. stock market. This brought the U.S. equity position up to 50%, which is close to the maximum that we can hold. With the rally we have had so far this year in U.S. equities, this has worked out well for us. Our second largest position has been in foreign equity markets, though we (over, please) The following information was represented as a line graph The Value of a $10,000 Investment in the Blanchard Global Growth Fund inception 6/1/86 through 4/30/95 as compared to the Standard & Poor's 500 for the same period ----------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Global Growth Fund* ----------------------------------- 1 year -1.04% ----------------------------------- 5 year 5.67% ----------------------------------- since inception 7.59% -----------------------------------
FYE 4/30/87 FYE 4/30/88 FYE 4/30/89 FYE 4/30/90 FYE 4/30/91 FYE 4/30/92 FYE 4/30/93 GGF 31.38% -0.57% 7.54% 3.74% 4.61% 6.24% 6.08% S&P 500 18.10% -6.40% 22.80% 10.50% 17.60% 14.00% 6.60% $9,925 $13,039 $12,965 $13,943 $14,464 $15,131 $16.075 $17,053 $10,000 $11,810 $11,054 $13,575 $15,000 $17,640 $20,109 $21,437
Reflects deduction of $75 acct opening fee Blanchard Standard Global & Poor's Growth Fund 500(D) *The average annual returns quoted above do not reflect the deduction of the account opening fee and assume reinvestment of distributions. If fee was reflected, the returns would be lower. Total return includes changes in principal value. Average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: Standard & Poor's 500 is an unmanaged composite index of the U.S. Stock Market performance. ^Reflects deduction of the one-time $75 account opening fee. This chart is for comparative purposes only and is not intended to reflect on future performance of the BGGF or the index. are still a bit early on these investments, as the weak dollar has hurt overseas markets by suppressing exports in Europe and Japan. Even so, we are maintaining our exposure to foreign markets as we expect they will outperform the U.S. stock market in the second half of the year. During 1994, our allocation to the precious metals sector was minimal. We have only recently begun moving into these markets to any degree. Again, while we may be a bit early on this allocation, we are comfortable taking a position at this level due to the extremely favorable supply and demand equation in gold markets. In 1994, in light of the Fed's aggressive series of interest rate increases, we made substantial reductions in our bond holdings, both in the U.S. and abroad. While we are not planning to move heavily back into bonds at any time soon, if we were to do so, it would most likely be in foreign bonds as we believe they currently present a greater opportunity than U.S. issues. To sum up, we believe that the global economy is currently in a sustained growth phase. As a result of this view, we have used the Fund's diversification and flexibility to move out of cash and back into equities, positioning the portfolio to seek a higher level of growth. With approximately 80% of the portfolio in a combination of U.S. and foreign stocks, we are well positioned to take advantage of such a growth scenario. Sincerely, JB:ml Jeremy Biggs Chief Investment Officer Fiduciary Trust International Chief Asset Allocation Strategist of the Blanchard Global Growth Fund Distributed by Sheffield Investments, Inc. (1551) 00ARSL0695 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Shares Value ------ ----- U.S. EQUITY SECURITIES SECTOR (49.58%) Aerospace (0.84%) *Coltec Industries ............................. 40,000 $ 730,000 ----------- Automotive & Related (3.24%) Chevron Corp. ................................. 12,000 568,500 Chrysler Corp. ................................ 20,000 862,500 Cummins Engine Company Inc. ........................................ 15,000 671,250 Harley Davidson, Inc. ......................... 30,000 716,250 ----------- 2,818,500 ----------- Banking (4.03%) Citicorp ...................................... 25,000 1,159,375 First Tennessee National Corp. ................ 10,000 425,000 Nationsbank Corp. ............................. 20,000 1,000,000 Provident Bancorp ............................. 15,000 506,250 UJB Financial Corp. ........................... 15,000 410,625 ----------- 3,501,250 ----------- Broadcast, Radio & TV (0.36%) Comcast Corp. Class A Special ..................................... 20,000 315,000 ----------- Chemicals & Related (4.91%) EI duPont de Nemours & Co. .................... 17,000 1,119,875 Mallinckrodt Group Inc. ....................... 30,000 1,080,000 Monsanto Co. .................................. 10,000 832,500 Morton International .......................... 40,000 1,240,000 ----------- 4,272,375 ----------- Consumer & Related (7.03%) Craftmade International ....................... 10,000 82,500 Eastman Kodak Co. ............................. 30,000 1,725,000 Edison Brothers Stores Inc. ................... 70,000 1,050,000 Home Depot .................................... 25,000 1,043,750 Lancaster Colony Corp. ........................ 20,000 695,000 Mattel, Inc. .................................. 35,000 831,250 Sara Lee Corp. ................................ 25,000 696,875 ----------- 6,124,375 ----------- Electronics & Electrical (5.38%) Avnet, Inc. ................................... 25,000 1,112,500 Baker Hughes Inc. ............................. 30,000 675,000 General Electric Co. .......................... 20,000 1,120,000 Intel, Inc. ................................... 10,000 1,023,750 Mark IV Industries, Inc. ...................... 42,000 756,000 ----------- 4,687,250 ----------- Energy Related (4.44%) Brush Wellman Inc. ............................ 20,000 395,000 Burlington Resources Inc. ..................... 30,000 1,173,750 Cooper Industries, Inc. ....................... 13,000 507,000 El Paso Natural Gas ........................... 30,000 877,500 Tenneco, Inc. ................................. 20,000 917,500 ----------- 3,870,750 ----------- (Right Column) Shares Value ------ ----- Entertainment & Leisure (2.40%) Carnival Cruise Lines Class A ................. 40,000 $ 995,000 Time Warner, Inc. ............................. 30,000 1,098,750 ----------- 2,093,750 ----------- Financial Services (2.47%) American Express Co. .......................... 40,000 1,390,000 Cash America Investment, Inc. ........................................ 100,000 762,500 ----------- 2,152,500 ----------- Food, Beverage, & Tobacco (1.56%) Philip Morris Co., Inc. ....................... 20,000 1,355,000 ----------- Health Care (0.69%) *National Health Labs .......................... 40,000 600,000 ----------- Industrial & Related (2.02%) Minnesota Mining & Manufacturing ............................... 20,000 1,192,500 Motorola, Inc. ................................ 10,000 568,750 ----------- 1,761,250 ----------- Insurance (0.63%) Washington National Corp. ..................... 30,100 553,088 ----------- Oil & Related (0.47%) *Reading & Bates Corp. ......................... 50,000 412,500 ----------- Pharmaceuticals (2.80%) Pfizer, Inc. .................................. 18,000 1,559,250 Warner Lambert Co. ............................ 11,000 877,250 ----------- 2,436,500 ----------- Recreation & Related (0.40%) *Leslie's Poolmart ............................. 20,000 345,000 ----------- Retail (1.99%) J.C. Penney, Inc. ............................. 20,000 875,000 The Limited ................................... 40,000 855,000 ----------- 1,730,000 ----------- Telecommunications (3.92%) *Airtouch Communications ....................... 40,000 1,075,000 AT&T Corp. .................................... 15,000 761,250 SBC Communications ............................ 25,000 1,103,125 *TeleCommunications A Shares .................................... 25,000 478,125 ----------- 3,417,500 ----------- TOTAL U.S. EQUITY SECURITIES SECTOR (IDENTIFIED COST $40,542,572) ................................ 43,176,588 ----------- 3 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- FOREIGN SECURITIES SECTOR (18.88%) AUSTRALIA (0.63%) Machinery (0.17%) Broken Hill Proprietary ....................... 10,479 $ 152,543 ----------- Metals & Mining (0.13%) Western Mining Corp. .......................... 20,000 113,253 ----------- Paper Products (0.17%) Amcor Ltd. (ORD) .............................. 20,000 147,026 ----------- Publishing/Printing (0.16%) News Corporation Ltd. ......................... 31,320 138,371 ----------- TOTAL AUSTRALIA .......................... 551,193 ----------- CANADA (0.10%) Metals & Mining (0.10%) *Cominco Ltd. .................................. 5,000 83,655 ----------- FRANCE (2.32%) Consumer Goods & Related (0.30%) L'Oreal ....................................... 990 260,272 ----------- Electronics & Electrical (0.27%) Legrand ....................................... 160 231,451 ----------- Financial Services (0.52%) AXA ........................................... 4,600 242,243 Credit Local de France ........................ 2,500 212,820 ----------- 455,063 ----------- Food, Beverage, & Household (0.31%) LVMH Moet Hennessy ............................ 1,410 267,848 ----------- Housing & Construction (0.47%) Colas ......................................... 600 107,883 Compagnie de Saint Gobain ..................... 2,310 298,488 ----------- 406,371 ----------- Machinery (0.26%) Valeo (ORD) ................................... 4,050 230,394 ----------- Multi-Industry (0.05%) Primagaz cie Gaz .............................. 250 46,831 ----------- Textile & Apparel (0.14%) Castorama Dubois .............................. 720 119,074 ----------- TOTAL FRANCE ............................................ 2,017,304 ----------- GERMANY (1.47%) Chemicals & Related (0.27%) Linde AG ...................................... 402 230,915 ----------- Machinery (0.36%) Mannesmann .................................... 1,155 314,243 ----------- Medical Products & Related (0.58%) Fresenius (PFD) ............................... 445 282,234 Wella (PFD) ................................... 300 223,784 ----------- 506,018 ----------- Utilities & Related (0.26%) Veba AG ....................................... 615 228,935 ----------- TOTAL GERMANY ........................................... 1,280,111 ----------- (Right Column) Shares Value ------ ----- HONG KONG (0.60%) Airlines (0.15%) Swire Pacific Ltd., Class A ................... 20,000 $ 133,704 ----------- Banking (0.07%) Hong Kong & Shanghai Bank ..................... 5,431 62,968 ----------- Financial Services (0.14%) First Pacific ................................. 150,000 123,046 ----------- Real Estate (0.08%) Cheung Kong Hldgs. Ltd. ....................... 15,000 63,170 ----------- Utilities (0.16%) China Light & Power ........................... 12,000 56,582 Citic Pacific Ltd. ............................ 35,000 85,680 ----------- 142,262 ----------- TOTAL HONG KONG ......................................... 525,150 ----------- IRELAND (0.14%) Housing & Construction (0.14%) CRH PLC ....................................... 20,000 123,656 ----------- JAPAN (5.51%) Automotive (0.30%) Mabuchi Motor Co. Ltd. ........................ 4,000 264,160 ----------- Banking (0.60%) Mitsubishi Bank Ltd. ......................... 7,000 171,585 Mitsubishi Trust and Banking ................. 20,000 345,074 ----------- 516,659 ----------- Chemicals & Related (0.46%) Daicel Chemical Industry ..................... 35,000 204,902 Sekisui Chemical ............................. 16,000 199,905 ----------- 404,807 ----------- Electronics & Electrical Equipment (1.15%) Canon Sales Co. ............................... 10,000 264,160 Hitachi Zosen ................................. 50,000 239,767 Minebea Co., Ltd. ............................. 35,000 259,460 *Yaskawa Electric Corp. ........................ 50,000 239,766 ----------- 1,003,153 ----------- Financial Services (0.43%) Daiwa Securities Co. .......................... 15,000 189,196 Japan Securities Finance Co., Ltd ......................................... 12,000 188,482 ----------- 377,678 ----------- Housing & Construction (0.49%) Taisei Corp. Ltd. ............................. 25,000 172,834 Tostem Corp. .................................. 7,000 254,045 ----------- 426,879 ----------- Industrial & Related (0.55%) Asahi Glass Co. ............................... 20,000 261,780 Nippon Steel Corp. ............................ 55,000 218,586 ----------- 480,366 ----------- 4 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- Machinery (0.60%) Autobacs Seven ................................ 3,200 $ 333,936 Mori Spiki .................................... 10,000 186,817 ----------- 520,753 ----------- Real Estate (0.25%) Mitsubishi Estate Co. ......................... 18,000 216,326 ----------- Retail (0.44%) Ito Yokado Company, Ltd. ...................... 4,000 215,611 Jusco Ltd. .................................... 8,000 163,732 ----------- 379,343 ----------- Telecommunications (0.24%) DDI Corp. ..................................... 24 211,328 ----------- TOTAL JAPAN ............................................. 4,801,452 ----------- MEXICO (0.06%) Retail (0.06%) *Fotoluz Corp. ................................. 115,000 53,711 ----------- NETHERLANDS (1.64%) Electronics & Electrical (0.27%) Philips Electronics ........................... 6,200 236,403 ----------- Insurance (0.27%) Aegon NV ...................................... 3,030 235,164 ----------- Publishing/Printing (0.49%) Verenigde Ned. Uitg. .......................... 1,950 218,034 Wolters Kluwer ................................ 2,600 211,503 ----------- 429,537 ----------- Transportation (0.61%) Koninklijke Ahold NV .......................... 7,350 252,795 Koninklijke PTT Nederland NV .................. 7,950 277,016 ----------- 529,811 ----------- TOTAL NETHERLANDS ....................................... 1,430,915 ----------- NORWAY (0.23%) Multi-Industry (0.23%) Orkla AS ...................................... 4,600 197,278 ----------- SWEDEN (0.67%) Automotive (0.23%) Volvo Class B Free Shares ..................... 10,500 197,089 ----------- Consumer Related (0.21%) Autoliv AB .................................... 4,000 180,966 ----------- Industrial (0.23%) Saab Swedish Steel Class A .................... 4,600 202,734 ----------- TOTAL SWEDEN ............................................ 580,789 ----------- SWITZERLAND (1.53%) Consumer Related (0.20%) Merkur Hldgs. ................................. 670 181,776 ----------- Electronics & Electrical (.20%) Sulzer Gebrueder AG ........................... 300 171,421 ----------- Insurance (0.21%) Winterthur Schweiz ............................ 320 180,616 ----------- (Right Column) Shares Value ------ ----- Machinery (0.31%) BBC Brown Boveri Ltd. ......................... 275 $ 271,329 ----------- Medical Products & Related (0.31%) PSC Roche Hldgs. .............................. 45 270,283 ----------- Metals & Mining (0.30%) Alusuisse Lonza Hldgs ......................... 470 261,179 ----------- TOTAL SWITZERLAND ..................................... 1,336,604 ----------- UNITED KINGDOM (3.98%) Banking (0.19%) Bank of Ireland ............................... 30,000 162,193 ----------- Beverages (0.19%) Guinness PLC .................................. 22,500 169,977 ----------- Consumer Related (0.82%) Cadbury Schweppes PLC ......................... 35,000 252,019 Compass Group PLC ............................. 40,000 214,971 Greencore Group PLC ........................... 17,000 120,084 WM Morrison ................................... 55,000 128,323 ----------- 715,397 ----------- Electrical Equipment (0.40%) Powergen PLC .................................. 22,000 68,675 Siebe PLC ..................................... 30,452 275,865 ----------- 344,540 ----------- Entertainment & Leisure (0.17%) Granada Group ................................. 17,000 155,781 ----------- Health Care (0.44%) Smithkline Beecham Class A .................... 32,000 253,073 Takare (ORD) .................................. 40,000 128,081 ----------- 381,154 ----------- Housing & Construction (0.14%) CRH PLC ....................................... 20,000 121,806 ----------- Machinery (0.16%) Chubb Security PLC ............................ 29,000 140,455 ----------- Multi-Industry (0.29%) BTR PLC ....................................... 48,000 254,103 ----------- Oil Related (0.31%) British Petroleum PLC ......................... 37,223 268,026 ----------- Retail (0.33%) Thorne-Emi PLC 15,538 284,268 Telecommunications (0.28%) Carlton Communications PLC..................... 16,000 243,033 ----------- Transportation (0.26%) Principal --------- British Airways Conv. Bond 9.75%, 6/15/05 ..............................L 79,000 224,677 ----------- TOTAL UNITED KINGDOM .................................. 3,465,410 ----------- TOTAL FOREIGN SECURITIES SECTOR (IDENTIFIED COST $15,019,502) ....................... 16,447,228 ----------- 5 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- EMERGING MARKETS SECTOR (12.69%) ARGENTINA (0.58%) Consumer Goods & Related (0.33%) BAESA (ADR) ................................... 5,900 $ 162,250 Quilmes Industrial S.A. ....................... 6,500 123,500 ----------- 285,750 ----------- Utilities & Related (0.25%) Compania Naviera Perez Companc "B" Shares .......................... 26,970 110,032 YPF Sociedad Anonima .......................... 5,400 109,350 ----------- 219,382 ----------- TOTAL ARGENTINA ....................................... 505,132 ----------- BRAZIL (1.72%) Basic Industries (0.94%) Acesita PN (ADR) .............................. 12,864 197,635 Compania Vale Do Rio Doce (ADR) ....................................... 4,600 192,400 Usiminas (ADR) ................................ 34,600 417,546 ----------- 807,581 ----------- Capital Goods (0.20%) *Rhodia Ster (GDR) ............................. 12,781 173,869 ----------- Energy Related (0.16%) *Electrobras "B" Shares ........................ 165,000 44,434 *Electrobas Common ............................. 345,500 95,310 ----------- 139,744 ----------- Industrial & Related (0.20%) *Cemig (ADR) ................................... 7,307 170,748 ----------- Telecommunications (0.22%) Telebras (ADR) ................................ 5,450 194,917 ----------- TOTAL BRAZIL .......................................... 1,486,859 ----------- CHILE (0.54%) Basic Industries (0.19%) Antofagasta Holdings .......................... 28,000 130,656 *Sociedad Quimica Y Minera (ADR) ....................................... 1,000 34,875 ----------- 165,531 ----------- Capital Goods (0.28%) Madeco S.A. (ADR) ............................. 5,300 154,363 Maderas Y Sinteticos Sociedad (ADS) ................................ 5,000 87,500 ----------- 241,863 ----------- Financial Services (0.07%) Banco O'Higgins (ADR) ......................... 3,500 63,875 ----------- TOTAL CHILE ........................................... 471,269 ----------- (Right Column) Shares Value ------ ----- CHINA (0.15%) Financial Services *China North Industries Investment Ltd. Class A ..................... 135,000 $ 135,000 ----------- COLOMBIA (0.44%) Banking (0.12%) (D)Banco Ganadero S.A. (ADS) ..................... 3,400 63,742 Banco Ganadero (GDR) .......................... 2,300 43,590 ----------- 107,332 ----------- Basic Industries (0.32%) Cementos Diamante (GDS) ....................... 12,700 277,749 ----------- TOTAL COLOMBIA ........................................ 385,081 ----------- ECUADOR (0.23%) Construction (0.23%) Cemento Nacional de Ecuador (GDR) ....................................... 864 203,040 ----------- HONG KONG (0.39%) Banking (0.16%) Dao Heng Group Ltd. ........................... 56,000 143,237 ----------- Multi Industry (0.04%) Champion Technology Holdings .................................... 399,000 30,411 *Star Paging Int'l. Wts. 12/31/96 .................................... 60,000 372 ----------- 30,783 ----------- Real Estate (0.04%) *Jardine Strategic Holdings, Inc. (PFD) .................................. 10,965 37,281 ----------- Shipping (.15%) *Shanghai Hai Xing Shipping Co. Ltd. Class "H" .......................... 700,000 130,216 ----------- TOTAL HONG KONG ..................................... 341,517 ----------- HUNGARY (0.11%) Capital Goods (0.09%) *Matav Rt. ...................................... 450 79,646 ----------- Consumer Goods & Related (0.02%) *Kekkut Asvanyiz Rt. (GDR) ...................... 2,100 18,213 ----------- TOTAL HUNGARY ......................................... 97,859 ----------- INDIA (1.08%) Basic Industries (0.34%) Principal Gujarat Ambuja Cements Ltd. Conv. Bond --------- 3.5%, 6/30/99 .............................. $70,000 90,125 Shares ------ *Hindalco Industries Ltd. (GDR) .................................. 3,700 96,200 United Phosphorus (GDR) ....................... 4,500 109,125 ----------- 295,450 ----------- 6 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- Consumer Goods & Related (0.20%) *DCW Limited (GDR) ............................. 3,500 $ 45,500 *Dr. Reddy's Laboratories Ltd. (GDR) ....................................... 12,200 128,100 ----------- 173,600 ----------- Investment Companies (0.54%) *Himalayan Fund ................................. 8,149 111,641 *Himalayan Fund Bonus Wts. 12/31/96 ................................ 1,130 706 *Indian Opportunities Fund Ltd. ................. 27,282 360,673 ----------- 473,020 ----------- TOTAL INDIA ........................................... 942,070 ----------- INDONESIA (0.40%) Chemicals (0.03%) *PT Keramika Indonesia Assoc. .................. 34,000 28,930 ----------- Capital Goods (0.09%) *PT Argha Karya Prima .......................... 32,000 22,929 *PT Indonesia Satellite (ADR) .................. 1,600 57,800 ----------- 80,729 ----------- Consumer Goods & Related (0.15%) PT Concord Benefit Textile Co. ................................. 35,000 69,749 *PT Kalbe Farma ................................ 7,500 26,702 PT Texmaco Jaya ............................... 57,600 30,954 ----------- 127,405 ----------- Financial Services (0.13%) Bank International Indonesia .................. 35,400 82,436 *PT Andyani Megah .............................. 30,000 26,870 ----------- 109,306 ----------- TOTAL INDONESIA 346,370 ----------- ISRAEL (0.28%) Financial Services (0.13%) *Ampal American Israel Wts. 1/31/99 ................................ 8,600 4,842 *Ampal American Israel Class A ................. 6,400 40,800 *PEC Israel Economic Corp. ..................... 2,500 69,063 ----------- 114,705 ----------- Investment Companies (0.09%) First Israel Fund ............................. 6,700 80,400 ----------- Multi-Industry (0.06%) Scitex Ltd. ................................... 2,241 51,263 ----------- TOTAL ISRAEL 246,368 ----------- (Right Column) Shares Value ------ ----- KOREA (1.37%) Capital Goods (0.13%) *Anam Industrial Co., Ltd. (PFD) ....................................... 5,000 $ 62,898 *Dae Woo Heavy (PFD) ........................... 6,000 50,764 ----------- 113,662 ----------- Consumer Goods & Related (0.01%) *Kia Motors Corp. .............................. 281 4,349 ----------- Construction & Housing (0.07%) *Kumho Construction & Energy Co. Ltd. Pfd. ............................... 9,000 63,160 ----------- Electrical & Electronics (0.16%) *Samsung Electronics ........................... 1,694 138,644 ----------- Financial Services (0.24%) *Commercial Bank of Korea ...................... 12,000 124,352 *Hanshin Securities Co., Ltd. (PFD) ....................................... 3,000 37,975 *Jin Heung Mutual Svgs. & Finance ..................................... 1,500 42,697 ----------- 205,024 ----------- Industrial & Related (0.14%) Hyundai Motor Service Co. (PFD) ....................................... 4,066 106,670 *Sammi Steel Co., Ltd. (PFD) ................... 2,000 12,068 ----------- 118,738 ----------- Oil & Related (0.02%) Principal Ssangyong Oil Refining --------- 3.0%, 12/31/04 .............................. $20,000 14,050 ----------- Retail & Related (0.10%) Shares ------ *Midopa Co. .................................... 7,000 87,230 ----------- Transportation (0.08%) *Dong Bang Forwarding Co. ...................... 1,700 69,351 ----------- Utilities & Related (0.42%) *Korea Electric Power Corp. (GDR) ....................................... 7,700 281,800 *Yukong Ltd. ................................... 2,000 88,673 ----------- 370,473 ----------- TOTAL KOREA ........................................... 1,184,681 ----------- MALAYSIA (0.42%) Consumer Goods & Related (0.06%) Edaran Otomobile Nasional (BHD) ....................................... 7,000 49,858 ----------- Financial Services (0.10%) Westmont Berhad ............................... 20,000 86,605 ----------- Industrial & Related (0.26%) Aokam Perdana Berhad .......................... 51,400 230,894 ----------- TOTAL MALAYSIA ....................................... 367,357 ----------- 7 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- MEXICO (0.61%) Basic Industries (0.01%) *Cemex "B" Wts. 7/29/96 ........................ 35,200 $ 282 ----------- Consumer Goods & Related (0.01%) *Cifra S.A. Wts 8/03/96 ........................ 83,000 2,490 ----------- Financial Services (0.41%) *Ceteco (ADS) .................................. 7,400 174,862 *Grupo Carso S.A. (ADR)......................... 10,000 108,526 *Grupo Carso Wts. 5/3/96 ....................... 16,200 17,172 *Grupo Financiero Banamex Wts. 6/29/95 ................................ 35,300 4,413 Kimberly Clark de Mexico (ADR) ....................................... 3,000 61,976 ----------- 366,949 ----------- Telecommunications (0.18%) *Millicom International Cellular ............... 6,400 159,200 *Telefonos de Mexico BZW Wts. July 1995 .......................... 10,700 1,070 ----------- 160,270 ----------- TOTAL MEXICO .......................................... 529,991 ----------- PAKISTAN (0.01%) Basic Industries (0.01%) *D.G. Khan Cement Ltd. ......................... 4,043 5,573 ----------- PERU (1.18%) Capital Goods (0.31%) Cementos Lima "C" Shares ...................... 7,000 155,174 Cementos Norte Pacasmayo ...................... 9,966 34,672 *Southern Peru Copper, Class "T" Shares ............................ 17,374 77,881 ----------- 267,727 ----------- Financial Services (0.27%) Banco Wiese (ADR) ............................. 7,712 69,410 *Banco Wiese "C" Shares ........................ 1 2 Banco de Credito del Peru ..................... 78,805 165,202 ----------- 234,614 ----------- Telecommunications (0.27%) *Compania Peruana de Telephonos .................................. 128,275 215,127 *La Neuva Com de Telefonos ..................... 30,014 24,365 ----------- 239,492 ----------- Real Estate (0.33%) *Peru Real Estate S.A. "B" Shares ...................................... 350,000 290,500 ----------- TOTAL PERU ......................................... 1,032,333 ----------- PHILIPPINES (0.06%) Financial Services (0.06%) *Filinvest Land Inc. ........................... 195,500 54,785 ----------- (Right Column) Shares Value ------ ----- POLAND (0.53%) Banking (0.14%) Bank Rozwoju Exsportu S.A. (PDR) .................................. 8,310 $ 122,451 ----------- Basic Industries (0.09%) *Mostostal Exports (PDR) ....................... 13,412 75,315 ----------- Capital Goods (0.15%) *Debica S.A. (PDR) ............................. 5,000 63,333 *Polifarb Ciezyn (PDR) ......................... 13,000 71,904 ----------- 135,237 ----------- Consumer Goods & Related (0.07%) Zwyeic Brewing Company (PDR) ....................................... 785 59,659 ----------- Financial Services (0.08%) Elektrim Trading Company (PDR) ....................................... 18,000 68,779 ----------- TOTAL POLAND 461,441 ----------- RUSSIA (0.06%) Telecommunications (0.06%) *Petersburg Long Distance Inc. ................. 10,060 51,558 ----------- SINGAPORE (0.33%) Basic Industries (0.13%) Clipsal Industries Hldgs., Ltd. ............... 53,000 114,480 ----------- Capital Goods (0.20%) GP Batteries Intl. Ltd. ....................... 25,000 60,000 *Sembawang Maritime Ltd. ....................... 27,000 113,307 ----------- 173,307 ----------- TOTAL SINGAPORE 287,787 ----------- SLOVENIA (0.07%) Banking (0.07%) *Slovenia Kredit Bank (IDR) .................... 200 58,454 ----------- SOUTH AFRICA (0.72%) Basic Industries (0.20%) *Iscor Ltd. .................................... 73,602 91,322 Sasol Ltd. .................................... 9,000 87,047 ----------- 178,369 ----------- Consumer Goods & Related (0.19%) *JD Group ...................................... 15,000 54,922 South African Breweries Ltd. .................. 4,000 110,535 ----------- 165,457 ----------- Financial Services (0.09%) Barlow Rand Ltd. .............................. 4,000 40,345 *Nedcor Ltd. ................................... 3,200 39,130 ----------- 79,475 ----------- Metals & Mining (0.10%) Samancor Ltd. ................................. 6,500 90,259 ----------- Real Estate (0.14%) Safmarine & Rennie Hldgs. Ltd. ........................................ 38,000 118,135 ----------- TOTAL SOUTH AFRICA .................................... 631,695 ----------- 8 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 (Left Column) Shares Value ------ ----- SRI LANKA (0.05%) Financial Services (0.05%) *Sri Lankan Growth ............................. 6,800 $ 43,350 *Sri Lankan Growth Wts. 3/1/98 ................................. 1,360 2,040 ----------- 45,390 ----------- TOTAL SRI LANKA ....................................... 45,390 ----------- TAIWAN (0.74%) Basic Industries (0.13%) *Tuntex Distinct (GDS) ......................... 9,524 111,907 ----------- Construction (0.16%) Principal Pacific Construction Conv. --------- Bond 2.13% 10/1/98 .......................... $150,000 140,993 ----------- Industrial & Related (0.01%) Shares ------ Asia Cement Corp. ............................. 190 3,800 ----------- Investment Companies (0.44%) *Taiwan Opportunities Fund Ltd. ................................... 37,500 387,000 ----------- TOTAL TAIWAN .......................................... 643,700 ----------- THAILAND (0.51%) Consumer Goods & Related (0.08%) *Hana Microelectronics ......................... 19,000 71,458 ----------- Financial Services (0.32%) General Finance & Securities .................. 36,000 143,444 MDX Co. Ltd. .................................. 40,000 82,944 Siam City Credit Finance & Securities ................................ 16,000 48,790 ----------- 275,178 ----------- Transportation (0.11%) Precious Shipping Corp. ....................... 10,000 107,339 ----------- TOTAL THAILAND 453,975 ----------- TURKEY (0.01%) Consumer Goods & Related (0.01%) Koc Yatirim ................................... 172 55 ----------- URUGUAY (0.10%) Financial Services (0.10%) Banco Commercial S.A. ......................... 6,600 85,800 ----------- TOTAL EMERGING MARKETS SECTOR (IDENTIFIED COST $12,742,396) .............................. 11,055,140 ----------- PRECIOUS METALS SECTOR (6.63%) METAL MINING SECURITIES (6.63%) CANADA (2.06%) *Dayton Mining Corp. ........................... 125,000 386,100 Franco Nevada Mining Ltd. ..................... 8,500 425,078 *Prime Resources Group, Inc. ................... 90,000 620,518 TVX Gold, Inc. ................................ 50,000 363,119 ----------- TOTAL CANADA .......................................... 1,794,815 ----------- (Right Column) Shares Value ------ ----- UNITED STATES (4.57%) Ashanti Gold Fields (GDR) ....................................... 28,000 $ 672,000 *Canyon Resources Corp. ....................................... 172,000 354,750 Homestake Mining .............................. 40,000 675,000 *Kinross Gold Corp. ............................ 100,000 600,000 Newmont Mining Corp. .......................... 16,000 670,000 Placer Dome, Inc. ............................. 13,000 308,750 Santa Fe Pacific Gold Corp. ....................................... 55,000 694,375 ----------- TOTAL UNITED STATES ................................ 3,974,875 ----------- TOTAL PRECIOUS METALS SECTOR (IDENTIFIED COST $5,846,039) ...................................... 5,769,690 ----------- U.S. FIXED INCOME SECURITIES SECTOR (8.66%) U.S. GOVERNMENT AND AGENCY ISSUES (8.66%) Principal (c)Government National --------- Mortgage Association TBA 9.0%, 6/01/09 ............................... $670,000 695,125 (c)Government National Mortgage Association TBA 10.0%, 5/01/19 .............................. 450,000 483,047 Government National Mortgage Association 6.5%, 2024 ................................ 1,861,337 1,701,034 U.S. Treasury Bond 7.50%, 11/15/24 ............................. 1,300,000 1,319,093 (b)U.S. Treasury Note 7.625%, 4/30/96 ............................. 1,680,000 1,700,474 U.S. Treasury Note 6.125%, 7/31/96 ............................. 840,000 837,112 U.S. Treasury Note 11.125%, 8/15/03 ............................ 650,000 813,109 ----------- TOTAL U.S. FIXED INCOME SECURITIES SECTOR (IDENTIFIED COST $7,467,790) ......................................... 7,548,994 ----------- OPTIONS (0.01%) Contracts *Nikkei 225 Call, --------- Expires 9/8/95 Strike @ 19.83 (IDENTIFIED COST $89,480) .................................... 60 853 ----------- 9 BLANCHARD GLOBAL GROWTH FUND-PORTFOLIO OF INVESTMENTS (continued) April 30, 1995 Princial Value -------- ----- SHORT-TERM SECURITIES (3.82%) Associates Corp. of N.A. 5.80%, 5/1/95 ...............................$2,000,000 $ 2,000,000 U.S. Treasury Bill 6.08%, 11/16/95 ............................. 630,000 609,767 U.S. Treasury Bill 6.21%, 1/11/96 .............................. 750,000 718,816 ----------- TOTAL SHORT-TERM SECURITIES (AMORTIZED COST $3,322,569) ......................................... 3,328,583 ----------- TOTAL INVESTMENTS (IDENTIFIED COST $85,030,348) (a)(100.27%) ........................... 87,327,076 LIABILITIES IN EXCESS OF CASH AND OTHER ASSETS (-0.27%) ..................................... (239,199) ----------- NET ASSETS (100%) ..................................... $87,087,877 =========== (Right Column) (a) The aggregate cost for federal income tax purposes is $85,120,015; the gross unrealized appreciation is $6,289,481 and the gross unrealized depreciation is $4,082,420; resulting in net unrealized appreciation of $2,207,061. (b) Security partially segregated to collateralize forward currency contracts and when issued securities. Total market value segregated is $1,690,352. (c) When-issued security (TBA is defined as "to be announced") * Non-income producing. (D) Registered under SEC rule 144-A, resale restricted as to qualified institutional buyers; represents 0.20% of net assets. SCHEDULE OF OPEN FORWARD CURRENCY CONTRACTS AS OF APRIL 30, 1995
Currency Unrealized Currency Sold Amount Purchased Amount Delivery Date Appreciation - ---------------------------------------------------------------------------------------------------- British Pounds 18,217 USD 29,365 May 1, 1995 $ 54 Swiss Francs 44,105 USD 39,100 May 2, 1995 624 ---- Total Unrealized Appreciation $678 ====
See notes to financial statements. 10 BLANCHARD GLOBAL GROWTH FUND Statement of Assets and Liabilities April 30, 1995 Assets: Investments in securities, at value (Identified Cost $85,030,348) ....................................... $87,327,076 Cash .................................................................. 1,516,999 Receivables for: Investments sold .................................................... 2,109,290 Shares of beneficial interest sold .................................. 4,353 Interest ............................................................ 156,305 Dividends ........................................................... 131,655 Forward currency contracts .......................................... 678 Foreign withholding tax reclaimable ................................. 4,985 ----------- Total assets 91,251,341 ----------- Liabilities: Payables for: Shares of beneficial interest repurchased ........................... 195,072 Investments purchased ............................................... 3,746,085 Foreign currency due to custodian (identified cost $72,424) ......... 71,957 Accrued expenses and other liabilities ................................ 150,350 ----------- Total liabilities ............................................... 4,163,464 ----------- Net assets ...................................................... $87,087,877 ----------- Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 8,972,356 shares outstanding) ....................... $87,241,249 Undistributed net investment income ................................... 1,644,700 Accumulated realized loss-net ......................................... (4,098,048) Unrealized net appreciation of investments and net currency translation adjustments ............................................. 2,299,976 ----------- Net assets ...................................................... $87,087,877 =========== Net asset value per share ....................................... $9.71 =====
See notes to financial statements. 11 BLANCHARD GLOBAL GROWTH FUND Statement of Operations For the Year Ended April 30, 1995 Investment income: Interest .................................................................................... $ 2,203,012 Dividends (net of $42,820 foreign withholding tax) .......................................... 1,011,758 ----------- Total income .......................................................................... 3,214,770 ----------- Expenses Investment management fee (note 2) .......................................................... 983,753 Plan of distribution fees (note 3) .......................................................... 704,436 Transfer agent fees ......................................................................... 252,300 Custodian fees .............................................................................. 141,871 Trustees' fees, retirement plan curtailment and other expenses (note 5) ..................... 118,674 Professional fees ........................................................................... 100,393 Accounting fees ............................................................................. 76,975 Shareholder reports and notices ............................................................. 44,976 Registration fees ........................................................................... 31,165 Other ....................................................................................... 14,834 ----------- Total expenses ........................................................................ 2,469,377 ----------- Net investment income ....................................................................... 745,393 ----------- Realized and unrealized gain (loss)-net (note 1): Realized gain (loss) on: Investments in securities-net (net of $42,557 capital gains tax) ............. $ (722,130) Forward currency contracts and foreign exchange transactions-net ........................................................... (2,370,796) Options (70,451) (3,163,377) ----------- Change in unrealized appreciation or depreciation on: Investments-net .............................................................. 352,187 Forward currency contract and translation of other assets and liabilities denominated in foreign currency-net .................................................... 434,719 786,906 ----------- ----------- Net realized and unrealized losses .......................................................... (2,376,471) ----------- Net decrease in net assets resulting from operations ........................................ $(1,631,078) ===========
See notes to financial statements. 12 BLANCHARD GLOBAL GROWTH FUND Statement of Changes in Net Assets April 30, 1995
For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income-net............................................ $ 745,393 $ 634,410 Realized gain (loss)-net......................................... (3,163,377) 10,101,136 Change in unrealized appreciation or depreciation-net............ 786,906 (1,424,538) ----------- ------------ Net increase (decrease) in net assets resulting from operations.. (1,631,078) 9,311,008 ----------- ------------ Dividends and distributions to shareholders from: Realized gains (losses)-net...................................... - (10,259,170) Distribution in excess of net realized gains .................... (2,156,307) - ----------- ------------ (2,156,307) (10,259,170) ----------- ------------ Transactions in shares of beneficial interest- net increase (decrease) (note 6)................................. (18,930,180) 25,973,929 ----------- ------------ Net increase (decrease) in net assets.............................. (22,717,565) 25,025,767 Net assets: Beginning of period................................................ 109,805,442 84,779,675 ----------- ------------ End of year (including undistributed and overdistributed net investment income of $1,644,700 and $334,578, respectivel........ $87,087,877 $109,805,442 =========== ============
See notes to financial statements. 13 BLANCHARD GLOBAL GROWTH FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1-Organization and Accounting Policies: Blanchard Global Growth Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940 (the "Act"). The Fund had no operations before June 1, 1986 other than the sale of 12,589 shares of beneficial interest for $100,714 to eight parties who are also shareholders or affiliates of shareholders of Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Bullion investments are valued at the closing spot price based on dealer or exchange quotations. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. The abilities of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a particular country, industry or region. B. Accounting for Investments and Investment Income Transactions-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date, except that certain dividends from foreign securities are recorded as soon as the Fund is informed after the ex-dividend date. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rates at the end of the period; and (2) purchases, sales, income and expenses are translated at the rates of exchange prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from 14 BLANCHARD GLOBAL GROWTH FUND NOTES TO FINANCIAL STATEMENTS (continued) changes in market prices of equity investments during the year. However, in accordance with the requirements of the Internal Revenue Code, the Fund isolates the effect of changes in foreign exchange rates from the fluctuations arising from changes in market prices of foreign debt obligations sold, and such foreign exchange losses, which amounted to $425,760, in fiscal 1995, are included in ordinary income for federal income tax purposes and in realized gain (loss) on forward currency contracts and foreign exchange transactions-net in the Statement of Operations. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, the level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future foreign rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. The Fund generally enters into a forward currency contract as a hedge against foreign exchange rate fluctuation upon the purchase or sale of a security denominated in a foreign currency. The Fund maintains, as collateral, U.S. Government or other highly liquid debt obligations in an amount equal to or greater than its net obligation for forward currency contracts. Risks may arise as a result of the potential inability of the counterparties to meet the terms of their contracts. Any capital or foreign currency loss incurred after October 31 through the end of the Fund's taxable year is deemed to arise on the first day of the Fund's next taxable year, if so elected. The Fund elected to defer a net capital loss of [ ] and net currency loss of [ ] incurred during the year in fiscal 1995. Future distributions may be impacted by the deferred net capital and currency losses, as well as other differences between book and taxable income. E. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains is determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income or net realized capital gains for financial reporting purposes but not for tax purposes are reported as distributions or dividends in excess of net investment income or net realized capital gains. To the extent they exceed net realized capital gains or net investment income for tax purposes, they are reported as distributions of paid-in capital. F. Other-Certain expenses of the Blanchard Group of Funds are allocated among the Funds based upon their relative average net assets during the year. NOTE 2-Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Mangers and the Allocation Strategist described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of 1% of the first $150 million of the Fund's average daily net assets, .875% of the Fund's average daily net assets in excess of $150 million but not exceeding $300 million and .75% of the Fund's average daily net assets in excess of $300 million. 15 BLANCHARD GLOBAL GROWTH FUND NOTES TO FINANCIAL STATEMENTS (continued) Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses for which a waiver has been obtained, are subject to the expenses limitation imposed by one state in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed the above limitation. Certain officers and/or Trustees of the Fund are officers/directors of the Manager. The Manager has sub-advisory agreements with Shufro, Rose and Ehrman (U.S. Equity Securities Sector), Fiduciary Trust International, Inc. (Foreign Securities Sector), Cavelti Capital Management, Ltd. (Precious Metals Sector), Investment Advisers, Inc. (U.S. Fixed Income Securities Sector), Fiduciary Trust International, Inc. (Foreign Fixed Income Sector), and Martin Currie Inc. (Emerging Markets Sector) (formerly managed by Morgan Stanley Asset Management, Inc.) (collectively, the "Portfolio Managers") to serve as the Portfolio Managers for their respective sectors of the Fund. The Manager has an agreement with Fiduciary Trust International, Inc. to be the Allocation Strategist of the Fund. All fees for such services are paid by the Manager. The Manager has advised the Fund that the aggregate amount of fees paid to the Portfolio Managers and Allocation Strategist was $373,411 for the year ended April 30, 1995. NOTE 3-Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor"), an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .75% per annum of the Fund's average daily net assets. Payments under the Plan will be made for expenses actually incurred by the Distributor. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after May 1, 1988, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $39,441. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4-Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Global Growth Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each 16 BLANCHARD GLOBAL GROWTH FUND NOTES TO FINANCIAL STATEMENTS (continued) Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3)certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5-Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $192,426,251 and $207,676,868, respectively, including purchases and sales of U.S. Government obligations of $45,646,200 and $51,504,331, respectively. For the year ended April 30, 1995, the Fund paid brokerage commissions of $186,095 to Shufro, Rose and Ehrman. The Distributor has advised the Fund that it received $75 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that, for the year ended April 30, 1995, it incurred costs, which were reimbursed by the Fund, amounting to $108,373 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the retainer fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees' fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $25,539. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $77,069 was recorded to reflect the previously unrecognized prior service costs of independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $102,608 of accrued pension expense. NOTE 6-Shares of Beneficial Interest:
For the Year Ended For the Year Ended April 30, 1995 April 30, 1994 ------------------ ------------------ Shares Amount Shares Amount ------ ------ ------ ------ Sold ............................. 1,720,51 $ 17,005,687 4,135,745 $ 43,740,249 Reinvestment of dividends and distributions .................. 219,892 2,049,709 949,799 9,754,435 ---------- ------------ --------- ------------ 1,940,403 19,055,396 5,085,544 53,494,684 Repurchased ...................... (3,905,396) (37,985,576) (2,622,307) (27,520,755) ---------- ------------ --------- ------------ Net increase (decrease) .......... (1,964,993) $(18,930,180) 2,463,237 $ 25,973,929 ========== ============ ========= ============
NOTE 7-Federal Income Tax: Any capital loss incurred after October 31 through the end of the Fund's taxable year is deemed to arise on the first day of the Fund's next taxable year, if so elected. The Fund elected to defer a net capital loss of $1,793,511 and a currency loss of $136,506 incurred during such period in fiscal 1995. 17 BLANCHARD GLOBAL GROWTH FUND NOTES TO FINANCIAL STATEMENTS (continued) As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to wash sales and post-October capital less deferrals. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $452,281, accumulated net investment income was credited $1,233,886 and accumulated realized loss-net was debited $781,605. At April 30, 1995, the Fund had a net capital loss carryover of $293,056, which is available through April 30, 2003 to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders. NOTE 8-Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the Year Ended April 30, ----------------------------------------------- Per Share Operating Performance: 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Net asset value, beginning of year .................. $10.04 $10.00 $ 9.92 $ 9.64 $ 9.62 ------ ------ ------ ------ ------ Income from investment operations: Net investment income ............................. .08 .03 .25 .33 .30 Net gains or losses on investments (both realized and unrealized) ........................ (.19) 1.29 .32 .26 .14 ------ ------ ------ ------ ------ Net income (loss) from investment operations .................. (.11) 1.32 .57 .59 .44 ------ ------ ------ ------ ------ Less dividends and distributions: Dividends from investment income-net .............. - (.00) (.30) (.31) (.21) Distributions from realized gains-net ............. - (1.28) (.19) - (.21) Distributions in excess of net realized gains ..... (.22) - - - - ------ ------ ------ ------ ------ Change in net asset value ..................... (.33) .04 .08 .28 .02 Net asset value, end of year ........................ $ 9.71 $10.04 $10.00 $ 9.92 $ 9.64 ====== ====== ====== ====== ====== Total return ........................................ (1.04%) 12.91% 6.08% 6.24% 4.61% Ratios/Supplemental Data: Net assets, end of year ($ Million) ............... $ 87 $110 $85 $128 $194 Ratio of expenses to average net assets ........... 2.51% 2.61% 2.40% 2.31% 2.36% Ratio of net investment income of average net assets .............................. .76% .67% 1.72% .31% 2.84% Portfolio turnover ................................ 221% 166% 138% 109% 78%
18 BLANCHARD GLOBAL GROWTH FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Global Growth Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Global Growth Fund (the "Fund") at April 30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian and brokers and the application of alternative procedures where confirmations were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 19 (Left Column) Portfolio Advisers Lombard Order International Portfolio Mot., Ltd. WLO Global Management Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Short-Term Global Income Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Short-Term Global Income Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD 100% TREASURY MONEY MARKET FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which Blanchard 100% Treasury Money Market Fund (the "FUND") is offered.^ - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS PAGE - ----------------- ---- Investment Objective and Policies .......................................... 2 Investment Restrictions .................................................... 2 Yield Calculation .......................................................... 3 Management of the FUND ..................................................... 4 Management Services ........................................................ 9 Portfolio Advisory Services ................................................ 9 Administrative Services .................................................... 10 Determination of Net Asset Value ........................................... 10 Portfolio Transactions ..................................................... 11 Dividends, Distributions and Tax Matters ................................... 13 Description of the FUND .................................................... 15 Shareholder Reports ........................................................ 16 Financial Statements ....................................................... A-1 Manager Virtus Capital Management, Inc. Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 INVESTMENT OBJECTIVE AND POLICIES The investment objective of the FUND is to seek the highest level of current income as is consistent with the preservation of capital and maintenance of liquidity. The FUND invests exclusively in short-term direct obligations of the U.S. Treasury. INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the Investment Company Act of 1940, as amended (the "1940 Act")) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. The FUND will not purchase a security if, as a result: (a) it would own more than 5% of any class or of the outstanding voting securities of any single company other than obligations of the U.S. Government or its agencies or instrumentalities; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets (other than obligations of the U.S. Government or its agencies or instrumentalities) would be concentrated in companies within any one industry as such industries are defined in the SIC/SEC Industries Code; or (d) more than 5% of total assets would be invested in warrants or rights. 2. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 10% of the market value of its total assets). The FUND will not purchase additional securities while borrowing is in excess of 5% of the market value of its total assets. 3. The FUND will not make loans of money or securities other than (a) through the purchase of U.S. Government obligations in accordance with its investment objective and (b) through repurchase agreements. 4. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities. 5. The FUND may not knowingly purchase or otherwise acquire securities which are subject to legal or contractual restrictions on resale or for which there is no readily available market and will not engage in repurchase transactions maturing in more than seven days if, as a result, more than 10% of the FUND's total assets would be invested in repurchase transactions maturing in excess of seven days. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 7. The FUND may not purchase or sell commodity contracts. 8. The FUND may not write, purchase or sell puts, calls, straddles, spreads or any combination thereof. -2- 9. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 10. The FUND may not invest in companies for the purpose of exercising control or management. 11. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 12. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and Trustees of the Manager, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 13. The FUND may not purchase or sell real estate. 14. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs; provided, however, that if consistent with the objective of the FUND, the FUND may purchase securities of issuers whose principal business activities fall within such areas. 15. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. YIELD CALCULATION The FUND provides current yield and effective yield quotations, which are calculated in accordance with the regulations of the Securities and Exchange Commission, based upon changes in account value during a recent specified period. Current yield quotations are computed by annualizing (on a 365-day basis) the "base period return". The "base period return" is computed by determining the net change exclusive of capital changes in the value of the account, divided by the value of the account at the beginning of the base period. Effective yield is computed by compounding the "base period return". The current and effective yield figures are not a representation of future yield as the FUND's net income and expenses will vary based on many factors, including changes in the types of instruments in the FUND's portfolio. The stated yield of the FUND may be useful in reviewing the FUND's performance and in providing a basis for comparison with other investment alternatives. However, unlike bank deposits and other investments which pay fixed yields for stated periods of time, the yield of the FUND fluctuates. In addition, other investment companies may calculate yield on a different basis and may purchase securities for their portfolios which have different qualities and maturities than those of the FUND's portfolio securities. -3- The FUND's current yield and effective yield for the seven day period ended April 30, 1995, were 3.89% and 3.97%, respectively. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds;
-4- formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region.
-5- Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Treasurer and Director of the Fund; President, and Treasurer and Trustee of Blanchard Precious Metals Fund, Inc.; President, Treasurer and Trustee of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds.
-6- Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. -7- Fund Ownership As of July 30, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 30, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. Officers and Trustees Compensation
- ------------------------------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - ------------------------------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex
-8- Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the fiscal years ended April 30, 1995, 1994 and 1993, the aggregate amounts paid or accrued by the FUND to the prior manager under the management agreement then in effect were $1,005,077, $851,522, and $588,587, respectively, after voluntary waivers of $220,924, $759,018 and $588,587, respectively. PORTFOLIO ADVISORY SERVICES Pursuant to a sub-advisory agreement (the "Sub-Advisory Agreement") between the prior manager and HSBC Asset Management Americas Inc. (the "Portfolio Adviser"), the prior manager had delegated to the Portfolio Adviser the authority and responsibility to make and execute decisions for the Fund within the framework of the Fund's investment policies, subject to review by the prior manager and the Board of Trustees of the Fund for the fiscal year ended April 30, 1995. The Sub-Advisory Agreement provides for the payment to the Portfolio Adviser by VCM, of monthly compensation for providing investment advice to the Fund and managing the investment of the assets of the Fund. VCM pays to the Portfolio Adviser an annual fee equal to the greater of .10% of the Fund's -9- average daily net assets or $50,000, annually. The Sub-Advisory Agreement provides that the Portfolio Adviser's fee shall be reduced proportionately based on the ratio of the Portfolio Adviser's fee to VCM's fee in the event VCM's fee is reduced as a result of a state expense limitation. For the fiscal years ended April 30, 1995, 1994 and 1993 the prior manager paid the Portfolio Adviser an aggregate of $200,998, $165,290 and $119,129, respectively, for services provided. Currently, VCM serves as manager to the FUND. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DETERMINATION OF NET ASSET VALUE The net asset value of the FUND is determined as of the close of trading (presently 4:00 p.m. New York time) on the New York Stock Exchange each day the Exchange is open for business excluding New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Substantially all of the FUND's net income calculated from the immediately preceding determination of net income, is declared daily as dividends. For the purpose of determining the price at which shares are issued and redeemed, the net asset value per share is calculated immediately after the daily dividend declaration by: (a) valuing all securities and instruments as set forth below; (b) deducting the FUND's liabilities; and (c) dividing the resulting amount by the number of shares outstanding. As discussed below, it is the intention of the FUND to maintain a net asset value per share of $1.00. The FUND's portfolio instruments are valued on the basis of amortized cost. This involves valuing an instrument at its cost and thereafter assuming a constant amortization to maturity of any discount or premium, regardless of the impact of fluctuating interest rates on the market value of the security. While this method provides certainty in valuation, it may result in periods during which value, as determined by amortized cost, is higher or lower than the price the FUND would receive if it sold its portfolio. During periods of declining interest rates, the daily yield on shares of the FUND computed as described above may be higher than a like computation made by a fund with identical investments utilizing a method of valuation based upon market prices and estimates of market prices for all of its portfolio instruments. Thus, if the use of amortized cost by the FUND results in a lower aggregate portfolio value on a particular day, a prospective investor in the FUND would be able to obtain a somewhat higher yield than would result from an investment in -10- a fund utilizing solely market values, and existing investors in the FUND would receive less investment income. The converse would apply in a period of rising interest rates. The FUND's use of amortized cost and the maintenance of the FUND's net value per share of $1.00 is based on its election to operate under the provisions of Rule 2a-7 under the 1940 Act. As a condition of operating under that rule, the FUND must maintain a dollar-weighted average portfolio maturity of 90 days or less, purchase only U.S. dollar denominated instruments having remaining maturities of 13 months or less, and invest only in securities which are determined by the Trustees to present minimal credit risks and which are rated in one of the two highest rating categories for debt obligations by at least two nationally recognized statistical rating organizations ("NRSROs") (or one NRSRO if the instrument was rated by only one such organization) or, if unrated, are of comparable quality as determined in accordance with procedures established by the Board of Trustees. Furthermore, investments in rated instruments not rated in the highest category by at least two NRSROs (or one NRSRO if the instrument was rated by only one such organization), and unrated instruments not determined by the Board of Trustees to be comparable to those rated in the highest category, will be limited to 5% of MMC's total assets, with the investment in any such issuer being limited to not more than the greater of 1% of MMF's total assets or $1 million. The Trustees have also agreed, as a particular responsibility within the overall duty of care owed to its shareholders, to establish procedures reasonably designed, taking into account current market conditions and the FUND's investment objective, to stabilize the net asset value per share as computed for the purposes of sales and redemptions at $1.00. These procedures include periodic review, as the Trustees deem appropriate and at such intervals as are reasonable in light of current market conditions, of the relationship between the amortized cost value per share and a net asset value per share based upon available indications of market value. In such review, investments for which market quotations are readily available are valued at the most recent bid price or quoted yield equivalent for such securities or for securities of comparable maturity, quality and type as obtained from one or more of the major market makers for the securities to be valued. Other investments and assets are valued at fair value, as determined in good faith by the Trustees. PORTFOLIO TRANSACTIONS Subject to the supervision of the Trustees and VCM, the Portfolio Adviser is responsible for decisions to buy and sell securities for the FUND. Since purchases and sales of portfolio securities by the FUND are usually principal transactions, the FUND will incur little or no brokerage commissions. Portfolio securities are normally purchased directly from the issuer or from a market maker for the securities. The purchase price paid to dealers serving as market makers may include a spread between the bid and asked prices. The FUND may also purchase securities from underwriters at prices which include a concession paid by the issuer to the underwriter. The Portfolio Adviser's primary consideration in effecting a security transaction is to obtain the best net price and the most favorable execution of the order. To the extent that the executions and prices offered by more than one dealer are comparable, the Portfolio Adviser may, in its discretion, effect transactions with dealers that furnish statistical, research or other information or services, which are deemed by the Portfolio Adviser to be beneficial to the FUND's investment programs. Certain research services furnished by dealers may be useful to the Portfolio Adviser with clients other than the FUND. Similarly, any research services received by the Portfolio Adviser through placement of portfolio transactions of other clients may be of value to the Portfolio Adviser in fulfilling its obligations to the FUND. -11- DIVIDENDS, DISTRIBUTIONS AND TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussions here and in the Prospectus is not intended as a substitutes for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. In addition to satisfying the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of -12- other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they will not qualify for the 70% dividends-received deduction for corporate shareholders. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend, will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his or her shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. -13- Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U. S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders -14- Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate, if any) upon the gross amount of the dividend. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends.. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to -15- circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. ^ SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. FINANCIAL STATEMENTS Audited financial statements of the Fund for the fiscal year ended April 30, 1995 are attached hereto. -16- Dear Shareholders, I'm pleased to report on the positive performance of your Blanchard 100% Treasury Money Market Fund for the fiscal year ended April 30, 1995. Although past performance is no guarantee of future results, I believe the past fiscal year's results demonstrate the Fund's ability to seek solid monthly income while placing special emphasis on capital preservation. The Year In Review During 1994 and into the first quarter of 1995, the Federal Reserve aggressively raised interest rates seven times. The final tightening was on February 1, 1995, when the Federal Reserve raised the Fed Funds level by 50 basis points (.50%) to 6.00%. The period represented a well-balanced economic expansion that reflected few imminent signs of substantial weakening, and the Federal Reserve was acting to forestall potential inflation. The domestic bond market suffered negative consequences this past year, as the increase in interest rates caused the prices of fixed income securities to decline. Consequently, in an interest rate environment reflecting higher rates, the Blanchard 100% Treasury Money Market Fund generated an increase in yields paid, while preserving your principal investment. Looking ahead to the upcoming year, we feel that the substantial slowdown in economic growth will cause the Federal Reserve to hold interest rates stable until the fourth quarter. Furthermore, we believe that the economy is heading toward a "soft landing," which is defined as a gradual slowdown in economic growth without incurring a recession. Because your Fund invests strictly in U.S. Treasury securities, it will continue to offer you a potentially "safe harbor" from any market volatility, while generating monthly income that is exempt from state and local taxes (except in Pennsylvania) _ so you'll keep more of what you earn. Additionally, the Fund's convenient free check writing privilege offers you immediate access at all times to the cash in your account. We look forward to being of continued service to you throughout this new fiscal year 1995. Rest assured that our highest priorities remain quality, safety, and performance for your investment with the Fund. Thank you for your continued confidence and support. Sincerely, EM:ml Edward J. Merkle Managing Director HSBC Asset Management Americas, Inc Portfolio Managers of the Blanchard 100% Treasury Money Market Fund The Fund is not guaranteed by the U.S. government. Yield is historic and will fluctuate, and there is no absolute guarantee that the Fund will be able to maintain a constant $1.00 share price. Distributed by Sheffield Investments, Inc. (1551) 02ARSL0695 BLANCHARD 100% TREASURY MONEY MARKET FUND PORTFOLIO OF INVESTMENTS April 30, 1995
Principal Value --------- ----- U.S. Government Obligations (97.1%) U.S. Treasury Bill 5.548% 5/04/95................ $48,000,000 $ 47,977,820 U.S. Treasury Bill 5.724% 5/11/95................ 2,210,000 2,206,492 U.S. Treasury Bill 5.923% 5/25/95................ 1,600,000 1,593,706 U.S. Treasury Bill 5.680% 6/01/95................ 87,170,000 86,745,708 U.S. Treasury Bill 5.773% 6/22/95................ 3,300,000 3,272,705 U.S. Treasury Bill 5.343% 8/24/95................ 18,950,000 18,632,462 ------------ Total Investments (Amortized Cost $160,428,893)(a)(97.1%)........ 160,428,893 CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (2.9%)................... 4,725,666 ------------ NET ASSETS (100%)................................ $165,154,559 ============ (a) The amortized cost for book purposes and cost for federal income tax purposes are the same.
See notes to financial statements. 2 BLANCHARD 100% TREASURY MONEY MARKET FUND STATEMENT OF ASSETS AND LIABILITIES April 30, 1995 Assets: Investments in securities, at value (Amortized Cost $160,428,893) (note 1)...................... $160,428,893 Cash.......................................................... 223,138 Receivables for: Investments sold............................................ 3,375,000 Shares of beneficial interest sold.......................... 1,719,677 Interest.................................................... 65,390 ------------ Total assets.............................................. 165,812,098 ------------ Liabilities: Payables for: Shares of beneficial interest repurchased................... 366,426 Dividends to shareholders................................... 33,415 Accrued expenses and other liabilities........................ 257,698 ------------ Total liabilities......................................... 657,539 ------------ Net assets (unlimited authorized shares of beneficial interest, $.01 par value, 165,260,846 shares outstanding)............... $165,154,559 ============ Net asset value per share....................................... $1.00 =====
See notes to financial statements. 3 BLANCHARD 100% TREASURY MONEY MARKET FUND STATEMENT OF OPERATIONS For the Year Ended April 30, 1995 Investment income: Interest......................................................... $9,612,788 Expenses Investment management fee (note 2)................... $1,005,077 Transfer agent fees.................................. 497,100 Trustees' fees, retirement plan curtailment and other expenses (note 4)............................ 237,009 Accounting fees...................................... 160,800 Professional fees.................................... 90,383 Shareholder reports and notices...................... 60,499 Registration fees.................................... 47,500 Custodian fees....................................... 35,499 Other................................................ 6,067 ---------- Total expenses................................... 2,139,934 Less: Fund expenses voluntarily waived by Manager (note 2)............................ (166,695) ---------- Net expenses..................................................... 1,973,239 ---------- Investment income--net increase in net assets resulting from operations...................................... $7,639,549 ==========
See notes to financial statements. 4 BLANCHARD 100% TREASURY MONEY MARKET FUND STATEMENT OF CHANGES IN NET ASSETS
For the Year For the Year Ended Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income-net increase resulting from operations................................. $ 7,639,549 $ 4,716,947 Dividends to shareholders from: Investment income-net........................ (7,639,549) (4,716,947) ------------ ------------ --- --- Transactions in shares of beneficial interest-net increase (decrease) (note 5).... (65,636,404) 65,816,563 ------------ ------------ Net increase (decrease) in net assets...... (65,636,404) 65,816,563 Net assets: Beginning of year............................ 230,790,963 164,974,400 ------------ ------------ End of year.................................. $165,154,559 $230,790,963 ============ ============
See notes to financial statements. 5 BLANCHARD 100% TREASURY MONEY MARKET FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1-Organization and Accounting Policies: Blanchard 100% Treasury Money Market Fund (the "Fund") is registered under the Investment Company Act of 1940, as amended (the "Act"), as a diversified open-end management investment company. It is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund commenced operations on February 24, 1989. A. Valuation of Investments-Portfolio securities are valued at amortized cost, which approximates market value. B. Accounting for Investments-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). In computing net investment income, the Fund amortizes any premiums or accretes any discounts on securities owned. Realized gains and losses on security transactions are determined on the identified cost method. C. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. D. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in-capital. E. Other-Certain expenses for the Blanchard Funds are allocated among the Funds based upon their relative average net assets. NOTE 2-Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), Sheffield Management Company, the Manager manages the Fund and the investment of the Fund's assets subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the portfolio adviser, HSBC Asset Management Americas, Inc. (formerly named Marinvest, Inc.), (the "Portfolio Adviser"). The Manager receives from the Fund an advisory fee payable monthly at an annual rate of .5% of the first $500 million of the Fund's average daily net assets, .475% of the Fund's average daily net assets in excess of $500 million but not exceeding $1 billion, plus .45% of the Fund's average daily net assets in excess of $1 billion. The Manager pays all fees of the Portfolio Adviser for its services. The Manager advised the Fund that it paid $200,998 to the Portfolio Adviser during the year ended April 30, 1995. 6 BLANCHARD 100% TREASURY MONEY MARKET FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 The Manager voluntarily waived a portion of its advisory fee, which amounted to $166,695, for the year ended April 30, 1995. Pursuant to the Agreement, the Manager provides continuous supervision of the investment portfolio, furnishes office space and facilities, maintains certain of the Fund's books and records, and pays the salaries and expenses of all personnel, including officers of the Fund, who are employees of the Manager and its affiliates. The Manager has advised the Fund that for the year ended April 30, 1995 it incurred costs, which were reimbursed by the Fund, amounting to $220,924 for performing internal accounting and transfer agency functions for the Fund. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, and extraordinary expenses, are subject to the expense limitations imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995 the Fund's expenses did not exceed such limitation. Certain officers and/or Trustees of the Fund are officers and/or directors of the Manager. NOTE 3-Acquisition Agreement: Sheffield Management Company ("the Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard 100% Treasury Money Market Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 4-Transaction with Affiliates: The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustee fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $52,296. As indicated in Note 3, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees for the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $154,090 was recorded to reflect previously unrecognized prior service costs of the independent director/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $206,386 of accrued pension expense. 7 BLANCHARD 100% TREASURY MONEY MARKET FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 5-Shares of Beneficial Interest: Transactions in shares of beneficial interest, all at $1 per share, were as follows:
For the Year For the Year Ended Ended April 30, 1995 April 30, 1994 -------------- -------------- Sold........................................ 212,621,088 340,832,974 Reinvestment of dividends................... 7,175,266 4,285,831 ----------- ----------- 219,796,354 345,118,805 Repurchased................................ (285,432,758) (279,302,242) ----------- ----------- Net increase (decrease).................... (65,636,404) 65,816,563 =========== ===========
NOTE 6-Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the Year Ended April 30, ----------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Per Share Operating Performance: Net asset value, beginning of year................ $1.00 $1.00 $1.00 $1.00 $1.00 ----- ----- ----- ----- ----- Income from investment operations: Net investment income........................... .04 .03 .03 .04 .07 Net gains or losses on securities (both realized and unrealized)................ .00 .00 .00 .00 .00 ----- ----- ----- ----- ----- Net income from investment operations......... .04 .03 .03 .04 .07 ----- ----- ----- ----- ----- Less Dividends to Shareholders: Dividends from investment income-net............ (.04) (.03) (.03) (.04) (.07) ----- ----- ----- ----- ----- Change in net asset value..................... .00 .00 .00 .00 .00 ----- ----- ----- ----- ----- Net asset value, end of year...................... $1.00 $1.00 $1.00 $1.00 $1.00 ===== ===== ===== ===== ===== Total return...................................... 4.02% 2.76% 3.42% 4.60% 6.80% Ratios/Supplemental Data: Net assets, end of year ($ Million)............. $165 $231 $165 $58 $38 Ratios of expenses to average net assets*(1).... .99% .41% .08% .86% 1.11% Ratios of net investment income to average net assets*(1)..................... 3.83% 2.80% 3.27% 4.52% 6.62% * The ratios of expenses to average net assets and net investment income to average net assets would have been 1.07% and 3.75%, respectively, for the year ended April 30, 1995, .93% and 2.29%, respectively, for the year ended April 30, 1994, .92% and 2.43%, respectively, for the year ended April 30, 1993, 1.46% and 3.92%, respectively, for the year ended April 30, 1992, 1.23% and 6.50%, respectively, and for the year ended April 30, 1991, if a portion of the Fund's expenses had not been voluntarily waived by the Manager. (1)Net of expenses waived and absorbed by Manager.
8 BLANCHARD 100% TREASURY MONEY MARKET FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard 100% Treasury Money Market Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard 100% Treasury Money Market Fund (the "Fund") at April 30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these finanical statements based on our audits. We conducted our audits of these finanical statements in accordance with generally acepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, asssessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 9 (Left Column) Portfolio Advisers Calveti Capital Management, Ltd. Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Precious Metals Fund, Inc. 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Precious Metals Fund, Inc. Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD SHORT-TERM GLOBAL INCOME FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Short-Term Global Income Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History ............................................ 2 Investment Objective and Policies .......................................... 2 Investment Restrictions .................................................... 12 Portfolio Transactions ..................................................... 13 Computation of Net Asset Value ............................................. 15 Performance Information .................................................... 16 Additional Purchase and Redemption Information ............................. 17 Tax Matters ................................................................ 18 The Management of the FUND ................................................. 23 Management Services ........................................................ 28 Portfolio Management Services .............................................. 29 Administrative Services .................................................... 30 Distribution Plan .......................................................... Description of the FUND .................................................... 30 Shareholder Reports ........................................................ 30 Appendix A ................................................................. A-1 Financial Statements ....................................................... B-1 Manager Virtus Capital Management, Inc. Portfolio Adviser Lombard Odier International Portfolio Management Limited Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. The FUND's investment objective is to provide high current income with minimum risk of principal and relative stability of net asset value. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with^ the sections in the FUND's Prospectus entitled "Investment Objective and Policies" and "Certain Investment Techniques and Policies." To achieve its objective, the FUND will invest in a portfolio consisting of debt obligations rated in the four highest rating categories of nationally recognized rating services denominated in various currencies, which have average remaining maturities not exceeding three years. The FUND may also invest in repurchase agreements, cash or cash equivalents or other such high quality debt instruments as is consistent with its objective. In addition, the FUND is authorized, for the purpose of increasing its yield or hedging its currency exposure, to engage in one or more of the specialized investment techniques and strategies described in the Prospectus under the caption "Certain Investment Techniques and Policies". The Fund will seek investment opportunities in foreign, as well as domestic, securities markets. While the FUND normally will maintain a substantial portion of its assets in debt securities denominated in foreign currencies, it is anticipated that, under normal circumstances, the FUND's assets will include securities in at least three countries, including the United States. The FUND currently does not intend to invest in securities issued by Eastern European countries. The FUND is designed for the investor who seeks a higher yield than a money market fund and less fluctuation in net asset value than a longer-term bond fund. In pursuing its investment objective, the FUND seeks to minimize credit risk and fluctuations in net asset value by investing only in shorter-term debt obligations. Although the FUND may invest in debt obligations having average remaining maturities of up to three years, it reserves the right to invest without limitation in debt obligations having substantially shorter remaining maturities during times of rapidly changing currency exchange rates or other uncertain market or economic conditions, or in anticipation of such times. The FUND invests in debt obligations denominated in the currencies of countries whose governments the Manager considers stable. In addition to the U.S. Dollar, such currencies include, among others, the Australian Dollar, Austrian Schilling, British Pound Sterling, Canadian Dollar, Danish Kroner, Dutch Guilder, European Currency Unit ("ECU"), Finnish Markka, French Franc, German Mark, Italian Lira, Japanese Yen, New Zealand Dollar, Norwegian Kroner, Portuguese Escudo, Spanish Peseta, Swedish Krona and Swiss Franc. An issuer of debt securities purchased by the FUND may be domiciled in a country other than the country in whose currency the instrument is denominated. The FUND seeks to minimize investment risk by generally limiting its portfolio investments to debt securities rated no lower than Baa by Moody's Investors Service, Inc. ("Moody's") or BBB by Standard & Poors Corporation ("S&P"). Accordingly, with respect to the debt securities and other investments described above, the FUND's portfolio consists only of: (i) debt securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities ("U.S. Government Securities"); (ii) obligations issued or guaranteed by a foreign government or any of its political subdivisions, authorities, agencies, or instrumentalities, or by supranational entities (which are described below) (collectively referred to as "Foreign Government Obligations"), which are rated no lower than Baa by Moody's or BBB by S&P or, if unrated, determined by FUND management to be of equivalent quality; (iii) corporate debt securities rated no lower than Baa by -2- Moody's or BBB by S&P or, if unrated, determined by FUND management to be of equivalent quality; (iv) certificates of deposit and banker's acceptances issued or guaranteed by, or time deposits maintained at banks, including foreign branches or subsidiaries of U.S. depository institutions ("Eurodollar" obligations) or U.S. branches or subsidiaries of foreign depository institutions ("Yankeedollar" obligations) or foreign branches or subsidiaries of foreign depository institutions, having total assets of more than $500 million and determined by FUND management to be of high quality; (v) commercial paper rated A-1 or A-2 by S&P, Prime-1 or Prime-2 by Moody's, Fitch-1 or Fitch-2 by Fitch Investors Service, Inc., Duff 1 or Duff 2 by Duff & Phelps Inc. or, if not rated, issued by U.S. or foreign companies having outstanding debt securities rated AAA, AA or A by S&P, or Aaa, Aa or A by Moody's and determined by Fund management to be of high quality, and loan participation interests having a remaining term not exceeding one year in loans extended to such companies by commercial banks or other commercial lending institutions whose long-term debt and commercial paper is rated AAA or AA by S&P or Aaa or Aa by Moody's ("a High Quality Rating"); (vi) repurchase agreements with respect to the foregoing debt securities; and (viii) futures contracts, options on futures contracts, options on foreign currencies, options on portfolio securities, and forward foreign currency exchange contracts. To further minimize investment risk, the FUND may only invest (a) up to 25% of its assets in securities rated no lower than A by Moody's or S&P (or, if unrated, determined by the Portfolio Manager to be of equivalent quality); (b) up to 10% of its assets in securities rated no lower than Baa by Moody's or BBB by S&P (or, if unrated, determined by the Portfolio Manager to be of equivalent quality; and (c) up to 10% of its assets in any such Foreign Government Obligations issued in any one country. The medium to lower-rated and unrated Foreign Government Obligations in which the FUND invests tend to offer higher yields than higher-rated securities with the same maturities. Debt obligations rated lower than A by S&P or Moody's tend to have speculative characteristics and generally involve more risk of loss of principal and income than higher-rated securities. For a description of the various ratings used by the ratings agencies, see Appendix A to this Statement of Additional Information. The FUND may invest in debt securities issued by supranational organizations such as: the World Bank, which was chartered to finance development projects in developing member countries; the European Community, which is a twelve-nation organization engaged in cooperative economic activities; the European Coal and Steel Community, which is an economic union of various European nations' steel and coal industries; and the Asian Development Bank, which is an international development bank established to lend funds, promote investment and provide technical assistance to member nations in the Asian and Pacific regions. The World Bank, Asian Development Bank and other such supranational organizations are not considered by the FUND or its management to be "banks" for purposes of computing investment restrictions regarding non-diversification or concentration policies and, as a result, the debt securities issued by such supranational organizations will not be included as banks for determination of compliance with the percentage limitations of such investment policies. The FUND may invest in debt securities denominated in the ECU, which is a "basket" consisting of specified amounts of the currencies of certain of the twelve member states of the European Community. The specific amounts of currencies comprising the ECU may be adjusted by the Council of Ministers of the European Community to reflect changes in relative values of the underlying currencies. The Manager does not believe that such adjustments will adversely affect holders of ECU-denominated obligations or the marketability of such securities. European supranationals, in particular, issue ECU-denominated obligations. The FUND also may purchase floating and variable rate demand notes and bonds, which are obligations ordinarily having stated maturities in excess of one year, but which permit the holder to demand payment of principal at any time, or at specified intervals not exceeding one year, in each case upon not more than 30 days' notice. Variable rate demand notes include master demand notes which are obligations that permit the FUND to invest fluctuating amounts, which may change daily without penalty, pursuant to direct arrangements between the FUND, as lender, and the borrower. The interest rates on these notes fluctuate from time to time. The issuer of such obligations normally has a corresponding right, after a given period, to prepay in its discretion the outstanding principal amount of the obligations plus accrued interest upon a specified number of days' notice to the holders of such obligations. The interest rate on a floating rate demand obligation -3- is based on a known lending rate, such as a bank's prime rate, and is adjusted automatically each time such rate is adjusted. The interest rate on a variable rate demand obligation is adjusted automatically at specified intervals. Frequently, such obligations are secured by letters of credit or other credit support arrangements provided by banks. Because these obligations are direct lending arrangements between the lender and borrower, it is not contemplated that such instruments will generally be traded, and there generally is no established secondary market for these obligations, although they are redeemable at face value. Accordingly, where these obligations are not secured by letters of credit or other credit support arrangements, the FUND's right to redeem is dependent on the ability of the borrower to pay principal and interest on demand. Such obligations frequently are not rated by credit rating agencies and the FUND may invest in obligations which are not so rated only if FUND management determines that, at the time of investment, the obligations are of comparable quality to the other obligations in which the FUND may invest. In making this determination, FUND management will consider on an ongoing basis the creditworthiness of the issuers of the floating and variable rate demand obligations in the FUND's portfolio. The FUND will not invest more than 10% of the value of its total assets in floating or variable rate demand obligations as to which it cannot exercise the demand feature on not more than seven days' notice if there is no secondary market available for these obligations, and in other securities that are not readily marketable. See "Investment Restriction No. 6" in this Statement of Additional Information. The FUND is a "non-diversified" investment company portfolio, which means that the FUND is not limited in the proportion of its assets that may be invested in the securities of a single issuer. However, the FUND intends to conduct its operations so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"), which will relieve the FUND of any liability for Federal income tax to the extent its earnings are distributed to shareholders. See "Distributions and Taxes." To so qualify, among other requirements, the FUND will limit its investments so that, at the close of each calendar quarter, (i) not more than 25% of the market value of the FUND's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value of its total assets will be invested in the securities of a single issuer and the FUND will not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the FUND's requirements to maintain diversification for tax purposes, the issuer of a loan participation will be the underlying borrower. In cases where the FUND does not have recourse directly against the borrower, both the borrower and each agent bank and co-lender interposed between the FUND and the borrower will be deemed issuers of the loan participation for tax diversification purposes. The FUND's investments in U.S. Government Securities are not subject to these limitations. Since the FUND, as a non-diversified investment company may invest in a smaller number of individual issuers than a diversified investment company, an investment in the FUND may, under certain circumstances, present greater risk to an investor than an investment in a diversified company. Futures contracts The FUND may enter into contracts for the purchase or sale for future delivery of fixed-income securities or foreign currencies which otherwise meet the FUND's investment policies, to the extent permitted by the Commodity Futures Trading Commission (the "CFTC"). U.S. futures contracts have been designed by exchanges which have been designated "contract markets" by the CFTC, and must be executed through a futures commission merchant, or brokerage firm, which is a member of the relevant contract market. Futures contracts trade on a number of contract markets, and, through their clearing corporations, the exchanges guarantee performance of the contracts as between the clearing members of the exchange. The FUND will enter into futures contracts which are based on debt securities that are backed by the full faith and credit of the U.S. Government, such as Treasury Notes, Government National Mortgage Association modified pass-through mortgage-backed securities and three-month U.S. Treasury Bills. The FUND may also enter into futures contracts which are based on non-U.S. Government bonds. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific, interest rate-sensitive financial instrument (debt security) at a -4- specified price, date, time and place. A foreign currency futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specified foreign currency at a specified price, date, time and place. The FUND may not enter into futures transactions if the sum of the amount of initial margin deposits on its existing futures contracts and premiums paid for unexpired options would exceed 5% of the fair market value of the FUND'S total assets, after taking into account unrealized profits and unrealized losses on commodity contracts it has entered into. The FUND will not use leverage when it enters into long futures or options contracts and for each such long position the FUND will deposit cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, having a value equal to the underlying commodity value of the contract as collateral with its custodian in a segregated account. The purpose of entering into a futures contract is to protect the FUND from fluctuations in the value of its portfolio securities without necessarily buying or selling the securities. Of course, because the value of portfolio securities will far exceed the value of the futures contracts sold by the FUND, an increase in the value of the futures contracts could only mitigate but not totally offset the decline in the value of the FUND's assets. No consideration is paid or received by the FUND upon entering into a futures contract. Upon entering into a futures contract, the FUND will be required to deposit in a segregated account with its custodian an amount of cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange on which the contract is traded and brokers may charge a higher amount). This amount is known as "initial margin" and 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 broker will have access to amounts in the margin account if the FUND fails to meet its contractual obligations. Subsequent payments, known as "variation margin," to and from the broker, will be made daily as the price of the currency or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract more or less valuable, a process known as "marking-to-market." At any time prior to the expiration of a futures contract, the FUND may elect to close the position by taking an opposite position, which will operate to terminate the FUND's existing position in the contract. There are several risks in connection with the use of futures contracts as a hedging device. Successful use of futures contracts is subject to the ability of FUND management to predict correctly movements in the price of the securities or currencies underlying the particular hedge. These predictions and, thus, the use of futures contracts involve skills and techniques that are different from those involved in the management of the portfolio securities being hedged. In addition, there can be no assurance that there will be a correlation between movements in the price of the underlying securities or currencies and movements in the price of the securities which are the subject of the hedge. A decision concerning whether, when and how to hedge involves the exercise of skill and judgment and even a well-conceived hedge may be unsuccessful to some degree because of unexpected market behavior or trends in interest rates or currency values. Positions in future contracts and options on futures contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange). No secondary market for such contracts exists. Although the FUND intends to enter into futures contracts only if there is an active market for such contracts, there is no assurance that an active market will exist for the contracts at any particular time. Most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting the FUND to substantial losses. In such event, and in the event of adverse price movements, the FUND would be required to make daily cash payments of variation margin. In such circumstances, an increase in the value of the portion of the FUND's securities being hedged, if any, may partially or completely offset losses on the futures contract. However, as described above, there is no guarantee that the price of the securities -5- being hedged will, in fact, correlate with the price movements in a futures contract and thus provide an offset to losses on the futures contract. If the FUND has hedged against the possibility of an event adversely affecting the value of securities held in its portfolio and that event does not occur, the FUND will lose part or all of the benefit of the increased value of securities which it has hedged because it will have offsetting losses in its futures positions. Losses incurred in hedging transactions and the costs of these transactions will affect the FUND's performance. In addition, in such situations, if the FUND had insufficient cash, it might have to sell securities to meet daily variation margin requirements at a time when it would be disadvantageous to do so. These sales of securities could, but will not necessarily, be at increased prices which reflect the change in interest rates or currency values, as the case may be. Options on Futures Contracts The FUND may purchase and write put and call options on interest rate and foreign currency contracts that are traded on a U.S. exchange or board of trade or a foreign exchange, to the extent permitted by the CFTC, as a hedge against changes in interest rates and market conditions, and may enter into closing transactions with respect to such options to terminate existing positions. There is no guarantee that such closing transactions can be effected. An option on an interest rate or foreign currency contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate or foreign currency contract at a specified exercise price at any time prior to the expiration date of the option. Options on interest rate futures contracts currently available include those with respect to U.S. Treasury Bonds, U.S. Treasury Notes, U.S. Treasury Bills and Eurodollars. Options on foreign currency futures currently available include those with respect to British Pounds, Swiss Francs, Japanese Yen, Canadian Dollars and Australian Dollars. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's futures margin account, which represents the amount by which the market price of the futures contracts exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The potential loss related to the purchase of an option on futures contracts is limited to the premium paid for the option (plus transaction costs). Because the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the net asset value of the FUND. There are several risks relating to options on futures contracts. The ability to establish and close out positions on such options will be subject to the existence of a liquid market. In addition, the purchase of put or call options will be based upon predictions as to anticipated trends in interest rates and securities markets and in currency values by VCM, which could prove to be incorrect. Even if VCM's expectations are correct, there may be an imperfect correlation between the change in the value of the options and of the portfolio securities hedged. Options on Foreign Currencies The FUND may purchase and write options on foreign currencies to increase its gross income and for hedging purposes in a manner similar to that in which futures contracts on foreign currencies, or forward contracts, will be utilized. For example, a decline in the dollar value of a foreign currency in which portfolio securities are denominated will reduce the dollar value of such securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of portfolio securities, the FUND may purchase put options on the foreign currency. If the value of the currency does decline, the FUND will have the right to sell such currency for a fixed amount in dollars and will thereby offset, in whole or in part, the adverse effect on its portfolio which otherwise would have resulted. -6- Conversely, where a rise in the dollar value of a currency in which securities to be acquired are denominated is projected thereby increasing the cost of such securities, the FUND may purchase call options thereon. The purchase of such options could offset, at least partially, the effects of the adverse movements in exchange rates. As in the case of other types of options, however, the benefit to the FUND deriving from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, where currency exchange rates do not move in the direction or to the extent anticipated, the FUND could sustain losses on transactions in foreign currency options which would require it to forego a portion or all of the benefits of advantageous changes in such rates. The FUND may write options on foreign currencies to increase its gross income and for the same types of hedging purposes. For example, where the FUND anticipates a decline in the dollar value of foreign currency denominated securities due to adverse fluctuations in exchange rates it could, instead of purchasing a put option, write a call option on the relevant currency. If the expected decline occurs, the option will most likely not be exercised, and the diminution in value of portfolio securities will be offset by the amount of the premium received. Similarly, instead of purchasing a call option to hedge against an anticipated increase in the dollar cost of securities to be acquired, the FUND could write a put option on the relevant currency which, if the currency moves in the manner projected, will expire unexercised and allow the FUND to hedge such increased cost up to the amount of the premium. As in the case of other types of options, however, the writing of a foreign currency option will constitute only a partial hedge up to the amount of the premium, and only if rates move in the expected direction. If this does not occur, the option may be exercised and the FUND would be required to purchase or sell the underlying currency at a loss which may not be offset by the amount of the premium. Through the writing of options on foreign currencies, the FUND also may be required to forego all or a portion of the benefits which might otherwise have been obtained from favorable movements in exchange rates. The FUND intends to write covered call options on foreign currencies. A call option written on a foreign currency by the FUND is "covered" if the FUND owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its Custodian or by a designated sub-custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the FUND has a call on the same foreign currency and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price or the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the FUND in cash, U.S. Government Securities and other high grade liquid debt securities in a segregated account with its Custodian or with a designated sub-custodian. As a writer of a covered put option, the FUND incurs an obligation to buy the security underlying the option from the purchaser of the put, at the option's exercise price at any time during the option period, at the purchaser's election (certain listed and over-the-counter put options written by the FUND will be exercisable by the purchaser only on a specific date). A put is "covered" if, at all times, the FUND maintains, in a segregated account maintained on its behalf at the FUND's custodian, cash, U.S. Government securities or other high grade obligations in an amount equal to at least the exercise price of the option, at all times during the option period. Similarly, a short put position could be covered by the FUND by its purchase of a put option on the same security (currency) as the underlying security of the written option, where the exercise price of the purchased option is equal to or more than the exercise price of the put written or less than the exercise price of the put written if the marked to market difference is maintained by the FUND in cash, U.S. Government securities or other high grade debt obligations which the FUND holds in a segregated account maintained at its custodian. The FUND also intends to write call options on foreign currencies that are not covered for cross-hedging purposes. A call option on a foreign currency is for cross-hedging purposes if it is not covered, but is designed to provide a hedge against a decline in the U.S. Dollar value of a security which the FUND owns or has the right to acquire and which is denominated in the currency underlying the option due to an -7- adverse change in the exchange rate. In such circumstances, the FUND collateralizes the option by maintaining in a segregated account with its Custodian or with a designated sub-custodian, cash or U.S. Government securities in an amount not less than the value of the underlying foreign currency in U.S. Dollars marked-to-market daily. Forward Currency Contracts The FUND may engage in currency exchange transactions to hedge against uncertainty in the level of future exchange rates. The FUND will conduct its currency exchange transactions either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through entering into forward contracts to purchase or sell currency. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. The FUND's dealings in forward currency contracts will be limited to hedging involving either specific transactions or portfolio positions. Transaction hedging is the purchase or sale of forward currency with respect to specific receivables or payables of the FUND generally accruing in connection with the purchase or sale of its portfolio securities. Position hedging is the sale of forward currency with respect to portfolio security positions denominated or quoted in the currency. The FUND may not position hedge with respect to a particular currency to an extent greater than the aggregate market value (at the time of making such sale) of the securities held in its portfolio denominated or quoted in or currently convertible into that particular currency. The FUND may, however, enter into a position hedging transaction with respect to a currency other than that held in the FUND's portfolio, if such a transaction is deemed to be a hedge by VCM . If the FUND enters into a position hedging transaction, cash or liquid high grade debt securities will be placed in a segregated account in an amount equal to the value of the FUND's total assets committed to the consummation of the forward contract. If the value of the securities placed in the segregated account declines, additional cash or securities will be placed in the account so that the value of the account will equal the amount of the FUND's commitment with respect to the contract. Hedging transactions may be made from any foreign currency into U.S. Dollars or into other appropriate currencies. At or before the maturity of a forward currency contract, the FUND may either sell a portfolio security and make delivery of the currency, or retain the security and offset its contractual obligation to deliver the currency by purchasing a second contract pursuant to which the FUND will obtain, on the same maturity date, the same amount of the currency which it is obligated to deliver. If the FUND retains the portfolio security and engages in an offsetting transaction, the FUND, at the time of execution of the offsetting transaction, will incur a gain or a loss to the extent that movement has occurred in forward currency contract prices. Should forward prices decline during the period between the FUND's entering into a forward contract for the sale of a currency and the date it enters into an offsetting contract for the purchase of the currency, the FUND will realize a gain to the extent the price of the currency it has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the FUND will suffer a loss to the extent the price of the currency it has agreed to purchase exceeds the price of the currency it has agreed to sell. The cost to the FUND of engaging in currency transactions varies with factors such as the currency involved, the length of the contract period and the market conditions then prevailing. Because transactions in currency exchange are usually conducted on a principal basis, no fees or commissions are involved. The use of forward currency contracts does not eliminate fluctuations in the underlying prices of the securities, but it does establish a rate of exchange that can be achieved in the future. In addition, although forward currency contracts limit the risk of loss due to a decline in the value of the hedged currency, at the same time, they limit any potential gain that might result should the value of the currency increase. If a devaluation is generally anticipated, the FUND may not be able to contract to sell the currency at a price above the devaluation level it anticipates. The FUND will not enter into a currency transaction if, as a result, it will fail to qualify as a regulated investment company under the Code for any given year. -8- Options on Portfolio Securities The FUND may write only covered call option contracts. Currently, the principal exchanges on which such options may be written are the Chicago Board Option Exchange and the American, Philadelphia, and Pacific Stock Exchanges. In addition, and in certain instances, the FUND may purchase and sell options in the over-the-counter market ("OTC Options"). A call option gives the purchaser of the option the right to buy the underlying security from the writer at the exercise price at any time prior to the expiration of the contract, regardless of the market price of the security during the option period. The premium paid to the writer is the consideration for undertaking the obligations under the option contract. The writer forgoes the opportunity to profit from an increase in the market price of the underlying security above the exercise price so long as the option remains open and covered, except insofar as the premium represents such a profit. The FUND may purchase options only to close out a position. In order to close out a position, the FUND will make a "closing purchase transaction", which involves the purchase of a call option on the same security with the same exercise price and expiration date as the call option that it has previously written on any particular security. The FUND will effect a closing purchase transaction so as to close out any existing call option on a security that it intends to sell. The FUND will realize a profit or loss from a closing purchase transaction if the amount paid to execute a closing purchase transaction is less or more than the amount received from the sale thereof. In determining the term of any option written, the FUND will consider the Code's limitations on the sale or disposition of securities held for less than three months in order to maintain its status as a regulated investment company. The staff of the Securities and Exchange Commission (the "Commission") has taken the position that purchased over-the-counter options and the assets used as cover for written over-the-counter options are illiquid securities. The FUND will write OTC Options only with primary U.S. Government Securities dealers recognized by the Board of Governors of the Federal Reserve System or member banks of the Federal Reserve System ("primary dealers"). The FUND may also write, to the extent available, OTC Options with non-primary dealers, such as foreign dealers; however, unlike OTC Options written with primary dealers, any OTC Options written with such non-primary dealers and the assets used as cover for such options will be treated as illiquid securities. In connection with these special arrangements, the FUND intends to establish standards for the creditworthiness of the primary and non-primary dealers with which it may enter into OTC Option contracts and those standards, as modified from time to time, will be implemented and monitored by VCM. Under these special arrangements, the FUND will enter into contracts with primary and non-primary dealers which provide that the FUND has the absolute right to repurchase an option it writes at any time at a repurchase price which represents the fair market value, as determined in good faith through negotiation between the parties, but which in no event will exceed a price determined pursuant to a formula contained in the contract. Although the specific details of the formula may vary between contracts with different primary and non-primary dealers, the formula will generally be based on a multiple of the premium received by the FUND for writing the option, plus the amount, if any, by which the option is "in-the-money." The formula will also include a factor to account for the difference between the price of the security and the strike price of the option if the option is written "out-of-the-money". Under such circumstances, and with respect to OTC Options written with primary dealers only, the FUND will treat as illiquid that amount of the "cover" assets equal to the amount by which the formula price for the repurchase of the option is greater than the amount by which the market value of the security subject to the option exceeds the exercise price of the option (the amount by which the option is "in-the-money"). Although each agreement will provide that the FUND's repurchase price shall be determined in good faith (and that it shall not exceed the maximum determined pursuant to the formula) the formula price will not necessarily reflect the market value of the option written, therefore, the FUND might pay more to repurchase the OTC Option contract than the FUND would pay to close out a similar exchange traded option. In determining the FUND's net asset value, the current market value of any option written by the FUND is subtracted from net asset value. If the current market value of the option exceeds the premium received by the FUND, the excess represents an unrealized loss, and, conversely, if the premium exceeds the current market value of the option, such excess would be unrealized gain. -9- Additional Risks of Options on Futures Contracts, Forward Contracts and Options on Foreign Currencies Unlike transactions entered into by the FUND in certain futures contracts, certain other futures contracts, options on foreign currencies and forward contracts are not traded on contract markets regulated by the CFTC and forward currency contracts are not regulated by the Commission. Instead, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board options Exchange, subject to regulation by the Commission. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the Commission, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the Options Clearing Corporation (the "OCC"), thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the FUND to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, futures contracts, options on futures contracts, forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Repurchase Agreements The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans as defined by the Investment Company Act of 1940, as amended (the "1940 Act"), collateralized by the underlying securities. The return on the collateral may be more or less than that from the -10- repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day so that the value of the collateral is at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, VCM will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. Lending of Portfolio Securities In order to generate additional income, the FUND may lend its portfolio securities in an amount up to 33-1/3% of total FUND assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities. No lending may be made to any companies affiliated with VCM. The borrower at all times during the loan must maintain with the FUND cash or cash equivalent collateral or provide to the FUND an irrevocable letter of credit equal in value at all times to at least 100% of the value of the securities loaned. During the time portfolio securities are on loan, the borrower pays the FUND any dividends or interest paid on such securities, and the FUND may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. Loans are subject to termination at the option of the FUND or the borrower at any time. The FUND may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the income earned on the cash to the borrower or placing broker. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by the FUND over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 5% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering". Section 4(2) instruments are restricted in the sense that they can only -11- be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The Commission has recently adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. As a non-diversified management investment company, the FUND has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within any one industry other than the banking industry (except that this restriction does not apply to U.S. Government Securities); or (d) more than 5% of net assets would be invested in warrants or rights. (Included within that amount, but not to exceed 2.0% of the value of the FUND's net assets, may be warrants which are not listed on the New York or American Stock Exchanges.) 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 20% of the market value of its total assets). This does not preclude the FUND from obtaining such short-term credit as may be necessary for the clearance of purchases and sales of its portfolio securities. The FUND will not purchase additional securities while the amount of any borrowings is in excess of 5% of the market value of its total assets. -12- 4. The FUND will not make loans of money or securities except (i) through repurchase agreements, (ii) through loan participations, and (iii) through the lending of its portfolio securities as described in "Lending of Portfolio Securities" in the Prospectus and in this Statement. 5. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities, except as they may be acquired as part of a merger, consolidation or acquisition of assets. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 7. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 8. The FUND may not invest in companies for the purpose of exercising control or management. 9. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 10. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 11. The FUND may not purchase or sell real property (including limited partnership interests, but excluding readily marketable interests in real estate investment trusts or readily marketable securities of companies which invest in real estate). 12. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs or leases. 13. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Manager subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreement between VCM and the Portfolio Manager. In selecting such brokers or dealers, the Portfolio Manager will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution -13- efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to the Portfolio Manager for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to the Portfolio Manager. Such allocation shall be in such amounts as VCM shall determine and the Portfolio Manager shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to the Portfolio Manager in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of the Portfolio Manager's other clients may be useful to the Portfolio Manager in carrying out its obligations to the FUND. The receipt of such research may not reduce the Portfolio Manager's normal independent research activities. The Portfolio Manager is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and the Portfolio Manager or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from brokerage commissions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the management fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between VCM and the Portfolio Manager does not provide for any reduction in the advisory fees as a result of profits resulting from brokerage commissions effected through the Portfolio Manager or an affiliated brokerage firm. The Trustees had adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid the Distributor or to the Portfolio Manager or an affiliated broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time". The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. It may happen that the same security will be held by other clients of VCM or of the Portfolio Manager. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. -14- COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The FUND may invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees. Portfolio securities of the FUND which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, normally 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 P.M. (New York Time) will be confirmed at the previous offering price computed as of the close of trading on the options exchanges (normally 4:15 P.M., New York Time), provided the order is received by the FUND's Transfer Agent prior to 4:15 P.M. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 P.M. will be confirmed at the next computed offering price. -15- PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's average annual total rates of return, reflecting the initial investment and reinvestment of all dividends and distributions, net of the pro rata share of the account opening fee, for the one year period ended April 30, 1995, and life of fund (January 8, 1991 to April 30, 1995) were -1.45% and 3.36%, respectively. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect until December 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the -16- FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: YIELD 2[(a-b+1)6-1] ---------- cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period.
Under this formula, interest earned on debt obligations for purposes of "all above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses; however, the FUND will disclose the pro rata share of the account opening fee. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this -17- limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to Federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses, including foreign currency gains and loss) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. If the FUND has a net capital loss (i.e., the excess of capital losses over capital gains) for any year, the amount thereof may be carried forward up to eight years and treated as a short term capital loss which can be used to offset capital gains in such years. At April 30, 1995, the Fund had a net capital loss of $7,705,131, which is available through April, 2003 to offset future gains. Under Section 852(b)(8) of the Code, any capital or foreign currency loss incurred after October 31 through the end of the Fund's taxable year is deemed to arise on the first day of the Fund's next taxable year, if so elected. The Fund elected to defer a net currency loss of $13,924,000 and a net capital loss of $3,036,000 incurred during such period in fiscal 1995. Future distributions may be impacted by the deferred net currency loss and net capital loss, as well as other differences between book and taxable revenue. Under the applicable foreign tax laws, a withholding tax may be imposed on interest and realized gains at various rates; such withholding taxes are reflected as a reduction of the related income. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or -18- futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a forward foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Section 1256, will generally be treated as ordinary income or loss. Generally, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even if a taxpayer's obligations (or rights) under such contract have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss (except for Section 1256 forward foreign currency contracts, which are subject to Section 988 Rules). The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service has held in several private rulings that gains arising from -19- Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss and any net foreign currency loss incurred after October 31 as if they had been incurred in the succeeding year. In addition to satisfying the requirements described above, the fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of its taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. However, with regard to forward currency contracts, there does not appear to be any formal or informal authority which identifies the issuer of such instrument. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) unless it has made a taxable year election, exclude foreign currency gains and losses incurred after October 31 of any year in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. -20- FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for Federal income tax purposes, but they will not qualify for the 70% dividends-received deduction for corporate shareholders. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consists of the stock or securities of foreign corporations, the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid his pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against Federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax advisor regarding the potential application of foreign tax credits. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends -21- are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign shareholder would generally be exempt from U.S. Federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the -22- sale of shares of the FUND will be subject to U.S. Federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. Federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. Federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. Federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The
-23- Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member, Board of Directors, Director of Corporate Health, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds.
-24- Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Treasurer and Trustee of the Fund; President, Treasurer and Trustee of Blanchard Precious Metals Fund, Inc., President, Treasurer and Trustee of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc.
-25- Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds.
- --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. -26- (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process. The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. -27- Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds. MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. -28- The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual Management fee as described in the prospectus. For the years ended April 30, 1995, 1994 and 1993, the aggregate amount paid or accrued by the FUND to the prior manager under the management agreement then in effect was $2,811,067, $4,845,290 and $8,417,706, respectively, of which $146,844 was waived by the prior manager during 1995. PORTFOLIO MANAGEMENT SERVICES Pursuant to a sub-advisory agreement (the "Sub-Advisory Agreement") between VCM and the portfolio manager, Lombard Odier International Portfolio Management Limited (the "Portfolio Manager"), VCM has delegated to the Portfolio Manager the authority and responsibility to make and execute decisions for the Fund within the framework of the Fund's investment policies, subject to review by ^ VCM and the Board of Trustees of the Fund. Under the terms of the Sub-Advisory Agreement, the Portfolio Manager has discretion to purchase and sell securities, except as limited by the Fund's investment objective, policies and restrictions. The Portfolio Manager has retained WLO Global Management, as sub-adviser, to assist in the investment management of the Fund pursuant to a Sub-Advisory Agreement, and subject to the direction of the Manager, the Portfolio Manager and the Board of Trustees of the Fund. Under the Sub-Advisory agreement, the Sub-Adviser has primary responsibility for providing investment advice to the Fund and managing the domestic (U.S.) investment of the Fund's assets, while the Portfolio Manager retains responsibility for international investments. The Sub-Advisory Agreement provides for the payment to the Portfolio Manager, by VCM, of monthly compensation based on the Fund's average daily net assets for providing investment advice to the Fund and managing the investment of the assets of the Fund. These fees are determined by applying the following annual rates to the Fund's average daily net assets: .35% of the Fund's net assets up to the first $10 million; .30% of the next $10 million of average daily net assets; .25% of the next $10 million of average daily net assets; .20% of the next $10 million of average daily net assets; and .15% of average daily net assets in excess of $40 million. The Agreement provides that the Portfolio Manager's fee shall be reduced proportionately based on the ratio of the Portfolio Manager's fee to VCM's fee in the event VCM's fee is reduced as a result of a state expense limitation. For the fiscal years ended April 30, 1995, 1994 and 1993, the aggregate amounts paid or accrued by the prior manager to the Portfolio Manager under the Sub-Advisory Agreement were $612,384, $1,039,688 and $1,752,821, respectively. The Sub-Advisory Agreement, dated July 11, 1995, was approved by the Fund's Directors on March 24, 1995 and the Fund's shareholders on July 11, 1995. The Sub-Advisory Agreement provides that is may be terminated without penalty by either the Fund or the Portfolio Manager at any time by the giving of 60 days' written notice to the other and terminates automatically in the event of "assignment", as defined in the Investment Company Act. The Sub-Advisory Agreement provides that, unless sooner terminated, it shall continue in effect from year to year only so long as such continuance is specifically approved at least annually by either the Board of Directors of the Fund or by a vote of the majority of the outstanding voting securities of the Fund, provided, that in either event, such continuance is also approved by the vote of the majority of the Directors who are parties to the Sub-Advisory Agreement or "interested persons" of such parties cast in person at a meeting called for the purpose of voting on such approval. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests For the fiscal year ended April 30, 1995, the Fund accrued payments under the Plan amounting to $937,022. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. -29- DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding share s of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. FINANCIAL STATEMENTS Audited financial statements of the Fund for the fiscal year ended April 30, 1995 are attached hereto. -30- APPENDIX A Description of Moody's Investors Service, Inc.'s Bond Ratings: Aaa: Bond which are rated Aaa are judged to be 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 fluctuations 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: Bond which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Baa: Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba: Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during other good and bad times over the future. Uncertainty of position characterizes bonds in this class. Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating classification from Aa through B (i.e., two categories below Baa) in its bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category, the modifier 2 indicates a mid-range ranking, and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. Description of Moody's Commercial Paper Ratings: Moody's commercial paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Issuers rated Prime-1 or P-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 or P-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.
A-1 - Well-established access to a range of financial markets and assured sources of alternate liquidity.
Issuers rated Prime-2 or P-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 alternate liquidity is maintained. Description of Standard & Poor's Corporation's Bond Ratings: AAA: Bonds rated AAA have the highest rating assigned by S&P to a debt obligation. capacity to pay interest and repay principal is extremely strong. AA: Bonds rated AA have a very strong capacity to pay interest; and repay principal and differ from the higher rated issues only in small degree. A: Bonds rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. BBB: Bonds rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds in higher rated categories. BB, B, CCC, CC, C: Debt rated "BB," "B," "CCC," "CC" and "C" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "C" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. BB: Debt rated "BB" has less near-term vulnerability to default than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. The "BB" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BBB-" rating. Plus (+) or Minus (-): The ratings from AA to CCC (i.e., three categories below BBB) may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. NR: Bonds may lack a S&P rating because no public rating has been requested, because there is insufficient information on which to base a rating, or because S&P does not rate a particular type of obligation as a matter of policy. Description of S&P's Commercial Paper Ratings: S&P's commercial paper ratings are current assessments of the likelihood of timely payment of debts having an original maturity of no more than 365 days. A: Issues assigned this highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-2 A-1: This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelming safety characteristics are denoted with a plus (+) sign designation. A-2: Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1". A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. Description of Fitch Investors Service, Inc. Four Highest Bond Ratings: AAA: Bonds in this category are considered to be investment grade and of the highest credit quality. The obligor has an exceptionally strong ability to pay interest and repay principal, which is unlikely to be affected by reasonably foreseeable events. AA: Bonds in this category are considered to be investment grade and of very high credit quality. The obligor's ability to pay interest and repay principal is very strong, although not quite as strong as bonds rated "AAA". As bonds rated in the "AAA" and "AA" categories are not significantly vulnerable to foreseeable future developments, short-term debt of these issuers is generally rated "F-1+". A: Bonds in this category are considered to be investment grade and of high credit quality. The obligor's ability to pay interest and repay principal is considered to be strong, but may be more vulnerable to adverse changes in economic conditions and circumstances than bonds with higher ratings. BBB: Bonds in this category are considered to be investment grade and of satisfactory quality. The obligor's ability to pay interest and repay principal is considered to be adequate. Adverse changes in economic conditions and circumstances, however, are more likely to have adverse impact on these bonds, and therefore, impair timely payment. Plus (+) or Minus (-): The ratings from AA to C (i.e. five categories below BBB) may be modified by the addition of a plus or minus sign to indicate the relative position of a credit within the rating category. NR: Indicates that Fitch does not rate the specific issue. Conditional: A conditional rating is premised on the successful completion of a project or the occurrence of a specific event. Description of Fitch's Four Highest Short-Term Ratings: Fitch's short-term ratings apply to debt obligations that are payable on demand or have original maturities of up to three years, including commercial paper, certificates of deposit, medium-term notes, and municipal and investment notes. F-1+: Exceptionally Strong Credit Quality. Issues assigned this rating are regarded as having the strongest degree of assurance for timely payment. F-1: Very Strong Credit Quality. Issues assigned this rating reflect an assurance of timely payment only slightly less in degree than issues rated "F-1+". A-3 F-2: Good Credit Quality. Issues carrying this rating have a satisfactory degree of assurance for timely payment, but the margin of safety is not as great as the "F-1+" and "F-1" categories. F-3: Fair Credit Quality. Issues carrying this rating have characteristics suggesting that the degree of assurance for timely payment is adequate, however, near-term adverse change is likely to cause these securities to be rated below investment grade. Description of Duff & Phelps Inc.'s Commercial Paper Ratings: Duff 1+: Highest certainty of timely payment. Short-term liquidity, including internal operating factors and/or ready access to alternative sources of funds, is clearly outstanding, and safety is just below risk-free U.S. Treasury short-term obligations. Duff 1: Very high certainty of timely payment. Liquidity factors are excellent and supported by good fundamental protection factors. Risk factors are minor. Duff 1-: High certainty of timely payment. Liquidity factors are strong and supported by good fundamental protection factors. Risk factors are very small. Duff 2: Good certainty of timely payment. Liquidity factors and company fundamentals are sound. Although ongoing internal funds needs may enlarge total financing requirements, access to capital markets is good. Risk factors are small. Duff 3: Satisfactory liquidity and other protection factors qualify issue as to investment grade. Risk factors are larger and subject to more variation. Nevertheless timely payment is expected. Notes with Respect to All Ratings: Bonds which are unrated expose the investor to risks with respect to capacity to pay interest or repay principal that are similar to the risks of lower-rated bonds. The Fund is dependent on Fund management's judgment, analysis and experience in the evaluation of such bonds. Investors should note that the assignment of a rating to a bond by a rating service may not reflect the effect of recent developments on the issuer's ability to make interest and principal payments. A-4 Dear Shareholders, Enclosed please find the annual report on the performance of your Blanchard Short-Term Global Income Fund for the fiscal year ending April 30, 1995, as well as the current outlook for the markets in which it has the flexibility to invest. As you know, 1994 was a particularly challenging year for fixed income investors, primarily because of two key market trends: First, global bond yields moved sharply higher in response to the re-emergence of economic growth throughout the developed world; second, the U.S. Federal Reserve returned to a policy of monetary tightening. In response to these trends, your Fund took a more cautious stance by reducing its exposure to short-dated bonds and increasing its exposure to cash deposits. Additionally, in an effort to increase overall yield, the Fund also took a small 5% position in the Mexican peso. However, this particular strategy suffered when the Mexican government unexpectedly devalued its currency in December. Exposure to "emerging markets" has since been reduced to zero. On a more positive note, since the beginning of 1995, there has been a marked change in investor sentiment for global bonds as investors have begun to realize that the threat of inflation may be misplaced. This realization has coincided with some evidence that the pace of economic expansion in the United States is slowing. While we still believe that there could be some pick-up in inflationary pressures, we feel that U.S. bond yields may have The following information was reprint as a line graph. The Value of a $10,000 Investment in the Blanchard Short-Term Global Income Fund from inception 1/8/91 through 4/30/95 as compared to the J.P. Morgan Cash Index for the same period ----------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Short-Term Global Income Fund* ----------------------------------------- 1 year -1.45% since inception 3.36% ----------------------------------------- FYE 4/30/91 FYE 4/30/92 FYE 4/30/93 FYE 4/30/94 FYE 4/30/95 STGF 2.15% 5.85% 4.97% 3.12% -1.45% J.P.M. CASH IDX 3.18% 8.17% 5.76% 2.68% 5.65% $9,925 $10,138 $10.731 $11.262 $11,613 $11,445 $10,000 $10,318 $11,161 $11,804 $12,120 $12,805 Reflects deduction of $75 acct opening fee Blanchard J.P. Morgan Short-Term Global Cash Income Fund^ Index(D) *The average annual returns quoted above do not reflect reinvestment of distributions, but do not reflect the deduction of the one-time account opening fee. If reflected, the returns would be lower. The total return includes changes in principal value. The average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: J.P. Morgan Cash Index is an unmanaged index based on the cash returns of constant maturity euro-currency deposits. ^Reflects deduction of one-time-only $75 account opening fee. This chart is for comparative purposes only and is not intended to reflect on future performance of the index or the BSTGIF. (over, please) further to fall as investors have yet to fully adjust to the fact that inflation is turning out to be lower than they had feared. Because of this, we, as managers of the portfolio, have decided to switch a vast majority of the Fund's assets into U.S. dollar denominated bonds _ while maintaining an exposure to European bonds (currently 30% of the Fund's total assets) in the core markets of Germany and Holland. There are some inflationary signs in Germany, but, as with the United States, these signs are limited. Any indication that the economy is slowing in Germany is likely to be well received by the bond markets and may exert a negative effect on German inflation. The Fund also has a small exposure to U.K. bonds, where we believe that investors have underestimated the resolve of the Bank of England and the government to control inflation. A Look Ahead Looking ahead, economic growth seems secure in most countries, although it is likely to decelerate somewhat in the United States as 1995 progresses. While past performance is no guarantee of future performance, the evidence so far suggests that the disinflationary trends of the 1980s have been sufficiently powerful to prevent a resurgence of inflation. Assuming any eventual upturn in inflation is modest in scale, the prevailing nominal bond yields throughout the world currently offer attractive value. Nevertheless, central banks will need to remain vigilant in order to convince investors that they will continue to take no risks with inflation. On our part, we will continue to closely monitor global interest rate and economic conditions, and, as warranted, make any necessary portfolio adjustments in pursuit of maximum return at lowest risk. Sincerely, RM:ml Robert McHenry Assistant Director Lombard Odier International Portfolio Management Ltd. Portfolio Managers of the Blanchard Short-Term Global Income Fund Distributed by Sheffield Investments, Inc. (1551) 03ARSL0695 BLANCHARD SHORT-TERM GLOBAL INCOME FUND-PORTFOLIO OF INVESTMENTS APRIL 30, 1995 (Left Column) Principal Value --------- ----- FOREIGN FIXED INCOME (26.34%) GERMANY (7.10%) GOVERNMENT/AGENCY (7.10%) Allemagne 6.63%, 1/20/98 ..... Dem 17,500,000 $ 12,887,568 Treuhandanat 6.13%, 6/25/98 ..... 5,100,000 3,703,978 ------------ TOTAL GERMANY ........ 16,591,546 ------------ NETHERLANDS (8.03%) GOVERNMENT/AGENCY (8.03%) Hollande 6.25%, 7/15/98 ..... Nlg 29,000,000 18,790,416 ------------ UNITED KINGDOM (11.21%) FINANCIAL SERVICES (5.99%) Abbey National 7.75%, 6/23/98 ..... (PS)1,000,000 1,574,870 Abbey National 6.0%, 8/10/99 ...... 2,225,000 3,242,286 Bayerische Hypotheken 7.0%, 12/21/98 ... 1,000,000 1,530,620 Halifax 7.75%, 12/03/98 .... 2,000,000 3,113,535 Leeds Permanent 7.38%, 5/06/98 ..... 830,000 1,285,440 Lloyds Bank 10.25%, 3/11/98 .... 1,000,000 1,665,379 National Providence Building 8.25%, 11/04/98 .... 1,000,000 1,586,938 ------------ 13,999,068 ------------ GOVERNMENT/AGENCY (5.22%) United Kingdom Treasury 7.0%, 11/06/01 ... (PS)8,140,000 12,217,760 ------------ TOTAL UNITED KINGDOM 26,216,828 ------------ TOTAL FOREIGN FIXED INCOME (IDENTIFIED COST $61,998,519) .... 61,598,790 ------------ U.S. FIXED INCOME (65.15%) AIRLINES (1.40%) *United Airlines Inc. Series A 10.67%, 5/01/04 ..... $3,000,000 3,268,370 ------------ COMPUTERS & RELATED (2.79%) Comdisco Inc. 7.25%, 4/15/98 ..... 5,000,000 4,998,800 Unisys Corp. Sr. Note 9.75%, 9/15/96 ..... 1,000,000 1,026,446 Unisys Corp. 9.5%, 7/15/98 ...... 500,000 500,750 ------------ 6,525,996 ------------ (Right Column) Principal Value --------- ----- CONSUMER RELATED (1.94%) RJR Nabisco 8.75%, 8/15/05 ..... $ 2,000,000 $ 1,942,688 Valassis Inserts 9.38%, 3/15/99 ..... 2,500,000 2,592,003 ------------ 4,534,691 ------------ ELECTRICAL UTILITIES (2.24%) Long Island Lighting 7.3%, 7/15/99 ...... 2,750,000 2,603,736 Niagara Mohawk Power Corp. 9.95%, 6/01/00 ..... 2,500,000 2,632,675 ------------ 5,236,411 ------------ ENTERTAINMENT (2.27%) Caesar's World Inc. Sr. Sub Notes 8.88%, 8/15/02 ..... 2,000,000 2,065,000 Time Warner Entertainment Co. 9.63%, 5/01/02 ..... 3,000,000 3,245,991 ------------ 5,310,991 ------------ FINANCIAL SERVICES (33.40%) Advanta MTC Series 1995 7.82%, 8/25/03 ..... 5,000,000 4,996,875 CMC Securities Corp. 1993 7.5%, 02/25/23 ........... 3,211,457 3,193,376 Chrysler Financial MTN 7.44%, 10/20/97 .... 5,000,000 5,013,220 Contimortage 1995-1 8.75%, 4/15/07 ..... 5,802,456 5,894,933 Dean Witter Discover & Co. 6.0%, 3/01/98 ...... 5,000,000 4,855,365 Discover Credit Corp. MTN 7.76%, 5/13/97 ..... 10,275,000 10,394,180 Ford Motor Credit Corp. 5.32%, 9/15/98 ..... 5,000,000 4,716,200 General Electric Capital Mtg. 1992 7.5%, 11/25/18 ..... 5,686,741 5,681,406 General Motors Acceptance Corp. 1993 B A 4.0%, 9/15/98 ...... 4,642,955 4,537,932 Groupe Videotron 10.63%, 2/15/05 .... 2,500,000 2,612,500 International Business Machines Credit 7.4%, 1/19/96 ...... 6,000,000 6,035,352 Lehman Brothers Hldg. MTN 8.63%, 2/26/99 ..... 5,000,000 5,104,805 Merrill Lynch Mtge. Inv. 1990 9.2%, 1/15/11 ...... 2,470,391 2,566,465 3 BLANCHARD SHORT-TERM GLOBAL INCOME FUND-PORTFOLIO OF INVESTMENTS (continued) APRIL 30, 1995 (Left Column) Principal Value --------- ----- (e)(D)New American Capital 7.69%, 7/12/95 ... $ 7,500,000 $ 7,500,000 Money Store Series 1995-A 8.0%, 9/15/05 .... 4,962,460 4,999,679 ------------ 78,102,288 ------------ GOVERNMENT/AGENCY (17.51%) Government National Mortgage Association, 9.5%, 12/15/21 ..... 5,000,000 5,262,500 (b)Resolution Trust Corp. 5.33%, 9/25/21 ..... 6,795,834 6,583,465 (b)Resolution Trust Corp. 5.83%, 9/25/19 ..... 3,559,951 3,453,152 Resolution Trust Corp. 5.9%, 7/25/23 ...... 2,728,754 2,701,466 (b)Resolution Trust Corp. 5.97%, 5/25/21 ..... 2,106,119 2,042,936 (b)Resolution Trust Corp. 6.98%, 3/25/22 .. 2,093,821 2,088,586 (b)Resolution Trust Corp. 7.32%, 11/25/25 .... 2,340,164 2,305,062 Resolution Trust Corp. 7.75%, 12/25/18 .... 6,456,497 6,424,214 Resolution Trust Corp. 7.87%, 9/25/29 ..... 3,886,383 3,879,096 (b)Resolution Trust Corp. 8.15%, 1/25/21 ..... 3,931,403 3,975,631 (b)Resolution Trust Corp. 8.77%, 3/25/21 ..... 937,699 937,230 Resolution Trust Corp. 8.8%, 8/25/23 ...... 1,273,000 1,303,234 ------------ 40,956,572 ------------ HOTELS (1.06%) Embassy Suites 8.75%, 03/15/00 ..... 2,500,000 2,487,500 ------------ INDUSTRY RELATED (1.81%) Oryx Energy Co. 9.75%, 9/15/98 ...... 2,500,000 2,521,875 (c)USX Corp. Subordinated Debenture 5.75%, 7/01/01 ..... 2,000,000 1,725,000 ------------ 4,246,875 ------------ (Right Column) Principal Value --------- ----- UTILITIES (.73%) Arkla Inc. 8.88%, 7/15/99 ..... $ 1,650,000 $ 1,699,106 ------------ TOTAL U.S. FIXED INCOME (IDENTIFIED COST $151,395,894) ........ 152,368,800 ------------ SHORT-TERM SECURITIES (6.40%) American Express Credit Corp. 5.7%, 5/01/95 ........ 1,000,000 1,000,000 Salomon Inc 5.91%, 9/29/95 ....... 5,000,000 4,976,730 U.S. Treasury Bill 4.56%, 5/04/95 ....... 9,000,000 8,995,800 ------------ TOTAL SHORT-TERM SECURITIES (IDENTIFIED COST $14,975,006) ......... 14,972,530 ------------ OUTSTANDING OPTIONS PURCHASED (0.03%) PUT OPTIONS Contracts --------- Euro$ Future expiring 9/18/95 @ $93.50 (d) ......... 150 75,000 ------------ TOTAL OUTSTANDING OPTIONS PURCHASED (IDENTIFIED COST $72,376) ........ 75,000 ------------ TOTAL INVESTMENTS (IDENTIFIED COST $228,441,795)(a) (97.92%) ............. 229,015,120 CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (2.08%) .............. 4,854,328 ------------ NET ASSETS (100%) ............... $233,869,448 ------------ *Securities partially segregated to collateralize forward currency contracts and options. Total market value segregated is $1,089,457. (D)Registered under SEC rule 144-A, resale restricted as to qualified institutional buyers; represents 3.21% of net assets. (a)The aggregate cost for federal income tax purposes is $228,444,420; the gross unrealized appreciation is $1,248,009; and the unrealized depreciation is $676,863; resulting in net unrealized appreciation of $571,146. (b)Variable rate security. Rate shown reflects the current rate as of April 30, 1995. (c)Convertible security. (d)Non-income producing. (e)Pays interest at LIBOR plus 137.5 basis points until July 12, 1995. After July 12, 1995 the rate resets to 7.69%. MTN = Medium Term Note See notes to financial statements. 4 BLANCHARD SHORT-TERM GLOBAL INCOME FUND-PORTFOLIO OF INVESTMENTS (continued) APRIL 30, 1995 Schedule of Open Forward Currency Contracts as of April 30, 1995 Unrealized Currency Currency Appreciation Sold Amount Purchased Amount Delivery Date (Depreciation) Dem 27,281,492 Nlg 30,561,000 2-May-95 $(21,420) Dem 20,246,000 Gbp 9,115,714 4-May-95 76,039 Dem 18,092,800 Itl 22,368,128,640 10-May-95 270,545 Itl 28,349,000,000 Dem 25,415,766 10-May-95 1,494,739 US$ 7,904,785 Jpy 778,400,000 10-May-95 1,371,578 US$ 10,000,000 Esp 1,289,950,000 10-May-95 471,053 US$ 24,600,661 Esp 3,075,082,650 10-May-95 385,791 ----------- Total Unrealized Appreciation $(4,091,165) =========== Nlg 30,561,000 Dem 27,281,735 10-May-95 $ (21,246) Gbp 7,490,400 US$ 11,879,774 10-May-95 (171,000) US$ 10,000,000 Aud 13,747,594 10-May-95 (1,822) US$ 15,000,000 Aud 20,270,270 10-May-95 (258,092) US$ 9,785,787 Aud 13,241,931 10-May-95 (147,651) Dem 48,433,000 US$ 34,643,997 10-May-95 (292,382) Itl 29,710,219,600 US$ 17,099,407 10-May-95 (547,643) Aud 45,976,000 US$ 33,333,979 10-May-95 (102,868) Dem 29,903,730 Itl 31,967,087,370 10-May-95 (2,583,016) Jpy 778,400,000 US$ 7,942,047 10-May-95 (1,334,316) Esp 4,461,200,000 US$ 34,348,630 10-May-95 (1,864,761) Gbp 9,170,090 Dem 20,246,000 4-Aug-95 (107,629) ----------- Total Unrealized Depreciation $(7,432,426) =========== Dem=Deutsche Marks Nlg=Dutch Guilders Esp=Spanish Pesetas Itl=Italian Lira Gbp=British Pounds Aud= Australian Dollars Jpy=Japanese Yen Schedule of Foreign Currency Held as of April 30, 1995 Currency Held Cost Market Value ------------- ---- ------------ Australian Dollars 138,898 $ 101,097 $ 101,097 British Pounds 45 73 73 Deutsche Marks 1,101 793 793 Italian Lira 5,162,758,058 3,032,897 3,072,156 Spanish Pesetas 17,655,177 143,456 143,456 ---------- ---------- $3,278,316 $3,317,575 ========== ========== See notes to financial statements. 5 BLANCHARD SHORT-TERM GLOBAL INCOME FUND (Left Column) STATEMENT OF ASSETS AND LIABILITIES April 30, 1995 Assets: Investments in securities, at value (Identified cost $228,441,795) (note 1) ................... $229,015,120 Cash ............................................ 2,426,706 Foreign currencies (Identified Cost $3,278,316) ..................................... 3,317,575 Receivables for: Investments sold .............................. 50,513,648 Shares of beneficial interest sold ............ 72,379 Interest ...................................... 3,600,873 Forward foreign currency contracts ............ 4,091,165 Deferred organizational expenses ............ 25,860 ------------ Total assets ............................ 293,063,326 ------------ Liabilities: Payables for: Shares of beneficial interest repurchased ................................. 761,158 Investments purchased ......................... 50,456,095 Dividends ..................................... 184,269 Forward foreign currency contracts ............ 7,432,426 Accrued expenses and other liabilities .......... 359,930 ------------ Total liabilities ....................... 59,193,878 ------------ Net assets .............................. $233,869,448 ============ Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 141,135,916 shares outstanding) ............... $259,231,663 Accumulated overdistributed investment income-net .................................... (12,018,933) Accumulated realized loss-net ................... (10,744,046) Unrealized net depreciation on investments, forward foreign currency contracts, options and net currency translation adjustments ................................... (2,599,236) ------------ Net assets ...................................... $233,869,448 ============ Net asset value per share ....................... $1.66 ===== (Right Column) STATEMENT OF OPERATIONS For the Year Ended April 30, 1995 Investment income: Interest (net of foreign withholding tax of $85,010) ................................. $27,791,428 ----------- Expenses: Investment manage- ment fee (note 2) .............$ 2,811,067 Plan of distribution fee (note 3) ......... 937,022 Transfer agent fees .... 779,000 Trustees' fees, retire- ment plan curtail- ment and other expenses (note 5) .... 403,258 Custodian fees ......... 337,214 Accounting fees ........ 230,000 Professional fees ...... 168,029 Shareholder reports and notices .......... 62,136 Organizational expenses (note 1) .... 26,748 Registration fees ...... 26,500 Other .................. 16,293 ----------- Total expenses ..... 5,797,267 Less: Fund expenses voluntarily waived by the Manager and Distributor .......... (182,085) 5,615,182 ----------- ----------- Net investment income ........................... 22,176,246 ----------- Realized and unrealized gain (loss) - net (note 1): Realized gain (loss) on: Investments in securities - net .......(10,489,372) Futures transac- tions - net ............ (521,197) Forward currency contracts and foreign exchange transactions - net .....(33,387,574) (44,398,143) ----------- Change in unrealized appreciation/ depreciation on: Investments - net ...... 7,167,814 Forward currency contracts, futures transactions and translation of other assets and liabilities denominated in foreign currency - net ... 8,408,763 15,576,577 ----------- ----------- Net realized and unrealized losses .................. (28,821,566) ----------- Net decrease in net assets resulting from operations ........................................ $(6,645,320) =========== See notes to financial statements. 6 BLANCHARD SHORT-TERM GLOBAL INCOME FUND STATEMENT OF CHANGES IN NET ASSETS
For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income - net $ 22,176,246 $ 41,432,828 Realized loss - net (44,398,143) (15,128,722) Change in unrealized appreciation or depreciation - net 15,576,577 (4,248,674) ------------ ------------ Net increase (decrease) in net assets resulting from operations (6,645,320) 22,055,432 ------------ ------------ Dividends and distributions to shareholders from: Investment income - net - (3,616,387) Tax return of capital (22,509,967) (37,657,313) ------------ ------------ (22,509,967) (41,273,700) Transactions in shares of beneficial interest - net decrease (note 6) (272,116,356) (144,823,458) ------------ ------------ Net decrease in net assets (301,271,643) (164,041,726) Net assets: Beginning of year 535,141,091 699,182,817 ------------ ------------ End of year (including accumulated overdistributed net investment income of $12,018,933 and $18,495,810, respectively) $233,869,448 $535,141,091 ============ ============
See notes to financial statements. 7 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard Short-Term Global Income Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940, as amended ("the Act"). The Fund had no operations before January 8, 1991 other than the sale of shares of beneficial interest to four parties who are also shareholders of Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. The abilities of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a particular country. B. Accounting for Investments-Security transactions are accounted for on the trade date (date the buy or sell order is executed). Realized gains and losses on security transactions are determined on the identified cost method. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Contracts & Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rates at the end of the period; and (2) purchases, sales, income and expenses are translated at the rates of exchange prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from changes in market prices of equity investments during the year. However, in accordance with the requirements of the Internal Revenue Code, the Fund isolates the effect of changes in foreign exchange rates from the fluctuations arising from changes in market prices of foreign debt obligations sold, and such net foreign exchange gains, which amounted to $2,904,998, are included in ordinary income for federal income tax purposes and in realized gain (loss) on forward currency contracts and foreign exchange transactions-net in the Statement of Operations. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. 8 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future exchange rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. The Fund generally enters into a forward currency contract as a hedge against foreign exchange rate fluctuation, upon the purchase or sale of a security denominated in a foreign currency. The Fund maintains, as collateral, U.S. Government or other highly liquid debt obligations in an amount equal to or greater than its net obligation for forward currency contracts. The Fund bears the risk of an unfavorable change in the foreign exchange rate underlying the forward contracts. Risks may also arise as a result of the potential inability of the counterparties to meet the terms of their contracts. Forward contracts involve elements of market risk in excess of the amount reflected in the Statement of Assets and Liabilities. D. Futures Contracts-A futures contract is an agreement between two parties to buy and sell a security at a set price on a future date. Upon entering into such a contract the Fund is required to pledge to the broker an amount of cash equal to the minimum "initial margin" requirement of the exchange on which the futures contract is traded. The contract amount reflects the extent of the Fund's exposure in these financial instruments. The Fund invests in futures contracts in order to hedge its existing portfolio securities against fluctuations in value caused by changes in prevailing interest rates. The Fund's participation in the futures markets involves certain risks, including the potential inability of the contract party to meet the terms of the contracts, imperfect correlation between movements in the price of futures contracts and movements in the price of securities hedged or used for cover. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the futures contracts and may realize a loss. Pursuant to a contract, the Fund agrees to receive from or pay to the broker an amount of cash equal to the daily fluctuation in value of the contract. Such receipts or payments are known as "variation margin" and are recorded by the Fund as unrealized appreciation or depreciation. The Fund maintains, as collateral, U.S. Government or other highly liquid debt obligations in an amount equal to or greater than its potential loss on futures contracts. When a contract is closed, the Fund records a realized gain or loss equal to the difference between the value of the contract at the time it was opened and the value at the time it was closed. E. Option Writing-When the Fund writes an option, an amount equal to the premium received by the Fund is recorded as a liability and is subsequently adjusted to the current market value of the option written. Premiums received from writing options which expire unexercised are treated by the Fund on the expiration date as realized gains. The difference between the premium and the amount paid on effecting a closing purchase transaction, including brokerage commissions, is also treated as a realized gain, or if the premium is less than the amount paid for the closing purchase transaction, as a realized loss. If a call option is exercised, the premium is added to the proceeds from the sale of the underlying security or currency in determining whether the Fund has realized a gain or loss. If a put option is exercised, the premium reduces the cost basis of the securities or currencies purchased by the Fund. The Fund as writer of an option may have no control over whether the underlying securities or currencies may be sold (called) or purchased (put) and as a result bears the market risk of an unfavorable change in the price of the security or currency underlying the written option. F. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. 9 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) G. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in capital. H. Organizational Expenses-The Fund's Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to approximately $133,706. The Fund has reimbursed the Manager for such expenses and deferred and is amortizing such expenses over five years from the date of commencement of the Fund's operations. I. Other-Certain expenses of the Blanchard Funds are allocated among the funds based upon their relative average net assets. NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of .75% of the Fund's average daily net assets. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses, are subject to the expense limitation imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed the above limitation. Certain officers and/or Trustees of the Fund are officers/directors of the Manager. The Manager has a sub-advisory agreement with Lombard Odier International Portfolio Management Limited (the "Portfolio Adviser"). The Manager has advised the Fund that the amount of fees paid to the Portfolio Adviser was $612,384 for the year ended April 30, 1995. The Manager and Distributor voluntarily waived a portion of the advisory and distribution fee, which amounted to $146,844 and $35,241, respectively, for the year ended April 30, 1995. NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor"), an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, 10 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealer and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .25% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $497,152. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Short-Term Global Income Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities of the year ended April 30, 1995, excluding short-term investments with maturities of less than one year at the time of purchase, aggregated $652,051,381 and $719,145,194, respectively, including purchases and sales of U.S. Government obligations of $66,275,242 and $5,226,497, respectively. The Distributor has advised the Fund that it received $11,700 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that, for the same period, it incurred costs amounting to $195,996, which were reimbursed by the Fund, for performing internal accounting and transfer agency functions for the Fund. Transactions in options written during the year ended April 30, 1995, were as follows:
Number of Premiums Contracts Received --------- -------- Written options outstanding at April 30, 1994 ....................... 601 $ 304,257 Options written ..................................................... 2,155 893,630 Options expired or terminated in closing purchase transactions ...... (2,756) (1,197,887) ------ ---------- Options outstanding at April 30, 1995 ............................... 0 $ 0 ====== ==========
11 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expenses included in Trustees' fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $73,214. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $277,539 was recorded to reflect the previously unrecognized prior service costs of the independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $350,753 of accrued pension expense. NOTE 6 - Shares of Beneficial Interest:
For the Year Ended For the Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold ...................... 46,167,838 $ 80,352,297 160,419,084 (298,532,697 Reinvestment of dividends . 10,834,258 18,687,481 20,537,136 38,161,388 ------------ ------------- ----------- ------------- 57,002,096 99,039,778 180,956,220 336,694,085 Repurchased ............... (214,657,986) (371,156,134) (259,498,407) (481,517,543) ------------ ------------- ----------- ------------- Net decrease .............. (157,655,890) $(272,116,356) (78,542,187) $(144,823,458) ============ ============= =========== =============
NOTE 7 - Federal Income Taxes Capital and foreign currency losses incurred after October 31 ("post-October losses") within the taxable year are deemed to arise on the first business day of the Fund's next taxable year. The Fund incurred and will elect to defer net capital and foreign currency losses of approximately $3,036,000 and $13,924,000, respectively during fiscal 1995. As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to post-October loss deferrals and non-deductible expenses. The Fund had permanent book/tax differences primarily attributable to foreign currency losses. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $40,341,564, accumulated realized loss-net was credited $33,530,966 and accumulated overdistributed investment income-net was credited $6,810,598. At April 30, 1995 the Fund had a net capital loss carryover of $7,705,131 which is available through April 30, 2003 to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders. 12 BLANCHARD SHORT-TERM GLOBAL INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) NOTE 8 - Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the Period January 8, 1991* For the Year Ended April 30, through 1995 1994 1993 1992 April 30, 1991 ---- ---- ---- ---- -------------- Per Share Operating Performance: Net asset value, beginning of period . $1.79 $1.85 $1.89 $1.95 $1.97 Income from investment operations: Net investment income .............. .10(D) .12 .13 .17 .06 Net gains or losses on investments (both realized and unrealized) ... (.07)(D) (.06) (.04) (.06) (.02) Net income (loss) from investment operations ... (.03) .06 .09 .11 .04 Less dividends and distributions: Dividends from investment income - net ..................... -- (.01) (.13) (.17) (.06) Tax return of capital .............. (.10) (.11) .00 .00 .00 Change in net asset value ...... (.13) (.06) (.04) (.06) (.02) Net asset value, end of period ....... $1.66 $1.79 $1.85 $1.89 $1.95 Total return .........................(1.45%) 3.12% 4.94% 5.85% 2.15%(3) Ratios/Supplemental Data: Net assets, end of period ($ Millions) ....................... $234 $535 $699 $1,241 $230 Ratio of expenses to average net assets ......................... 1.51%(2) 1.44% 1.44%(2) 1.32%(2) .38%(1)(2) Ratio of net investment income to average net assets ................. 5.95%(2) 6.41% 6.97%(2) 8.50%(2) 11.30%(1)(2) Portfolio turnover ................... 386% 327% 610% 412% 63%
- ------------ *Commencement of operations. (1)Annualized. (2)The ratios of expenses to average net assets and net investment income to average net assets would have been 1.56% and 5.90%, respectively, for the year ended April 30, 1995, unchanged for the year ended April 30, 1993, 1.41% and 8.41%, respectively, for the year ended April 30,1992 and 2.23% and 9.45%, respectively, for the period ended April 30, 1991 if the management and distribution fees had not been waived and with respect to the period ended April 30, 1991, other expenses had not been borne by the Manager. (3)Not annualized. (D)Calculated based on average shares outstanding. 13 BLANCHARD SHORT-TERM GLOBAL INCOME FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Short-Term Global Income Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Short-Term Global Income Fund (the "Fund") at April 30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the four years in the period then ended and for the period January 8, 1991 (commencement of operations) through April 30, 1991, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statement based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 14 (Left Column) Portfolio Advisers Lombard Odier International Portfolio Mgt. Ltd. WLO Global Management Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Short-Term Global Income Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Short-Term Global Income Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD PRECIOUS METALS FUND, INC. FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement of Additional Information is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which Blanchard Precious Metals Fund, Inc. (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS - ----------------- Page ---- Investment Objective and Policies .......................................... 2 Investment Restrictions .................................................... 10 Computation of Net Asset ................................................... 12 Performance Information..................................................... 12 Portfolio Transactions...................................................... 14 Dividends, Capital Gains Distributions and Tax Matters........................................................... 15 The Management of the Fund ................................................. 22 Management Services ........................................................ 26 Portfolio Management Services............................................... 27 Administrative Services..................................................... 27 Distribution Plan........................................................... 27 Description of the FUND..................................................... 28 Shareholder Reports......................................................... 28 Financial Statements........................................................ A-1 Manager - ------- Virtus Capital Management, Inc. Portfolio Adviser - ----------------- Cavelti Capital Management, Ltd. Distributor - ----------- Federated Securities Corp. Custodian - --------- United States Trust Company of New York Transfer Agent - -------------- United States Trust Company of New York Independent Accountants - ----------------------- Price Waterhouse LLP Dated: August 7, 1995 INVESTMENT OBJECTIVE AND POLICIES The investment objective and policies of the FUND are set forth in the FUND's Prospectus which refers to the following investment strategies and additional information: Options and Futures Strategies Through the writing and purchase of options and the purchase and sale of stock index futures contracts, interest rate futures contracts, foreign currency futures contracts and related options on such futures contracts, Virtus Capital Management, Inc. ("VCM") may at times seek to hedge against a decline in the value of securities included in the FUND's portfolio or an increase in the price of securities which it plans to purchase for the FUND or to reduce risk or volatility while seeking to enhance investment performance. Expenses and losses incurred as a result of such hedging strategies will reduce the FUND's current return. The ability of the FUND to engage in the options and futures strategies described below will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to stock indices, U.S. Government securities and foreign currencies are relatively new and still developing. Although the FUND will not enter into an option or futures position unless a liquid secondary market for such option or futures contract is believed by FUND management to exist, there is no assurance that the FUND will be able to effect closing transactions at any particular time or at an acceptable price. Reasons for the absence of a liquid secondary market on an Exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an Exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (iv) unusual or unforeseen circumstances may interrupt normal operations on an Exchange; (v) the facilities of an Exchange or the Options Clearing Corporation ("OCC") may not at all times be adequate to handle current trading volume; or (vi) one or more Exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market thereon would cease to exist, although outstanding options on that Exchange that had been issued by the OCC as a result of trades on that Exchange would continue to be exercisable in accordance with their terms. Low initial margin deposits made upon the opening of a futures position and the writing of an option involve substantial leverage. As a result, relatively small movements in the price of the contract can result in substantial unrealized gains or losses. However, to the extent the FUND purchases or sells futures contracts and options on futures contracts and purchases and writes options on securities and securities indexes for hedging purposes, any losses incurred in connection therewith should, if the hedging strategy is successful, be offset, in whole or in part, by increases in the value of securities held by the FUND or decreases in the prices of securities the FUND intends to acquire. It is impossible to predict the amount of trading interest that may exist in various types of options or futures. Therefore, no assurance can be given that the FUND will be able to utilize these instruments effectively for the purposes stated below. Furthermore, the FUND's ability to engage in options and futures transactions may be limited by tax considerations. Although the FUND will only engage in options and futures transactions for limited purposes, it will involve certain risks which are described in the Prospectus. The FUND will not engage in options and futures transactions for leveraging purposes. Writing Covered Options on Securities The FUND may write covered call options and covered put options on optionable securities of the types in which it is permitted to invest from time to time as Cavelti Capital Management, Ltd., the FUND's portfolio adviser (the "Portfolio Manager"), determines is appropriate in seeking to attain its objective. Call options written by the FUND give the holder the right to buy the underlying securities from the FUND at a stated exercise price; put options give the holder the right to sell the underlying security to the FUND at a stated price. -2- The FUND may write only covered options, which 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 comparable securities satisfying the cover requirements of securities exchanges). In the case of put options, the FUND will maintain, in a segregated account, cash or short-term U.S. Government securities with a value equal to or greater than the exercise price of the underlying securities or will hold a purchased put option with a higher strike price than the put written. The FUND may also write combinations of covered puts and calls on the same underlying security. The FUND will receive a premium from writing a put or call option, which increases the FUND's return in the event the option expires unexercised or is closed out at a profit. The amount of the premium will reflect, among other things, the relationship of the market price of the underlying security to the exercise price of the option, the term of the option and the volatility of the market price of the underlying security. By writing a call option, the FUND limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By writing a put option, the FUND assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its market value at the time it is exercised resulting in a potential capital loss if the purchase price is less than the underlying security's current market value minus the amount of the premium received, unless the security subsequently appreciates in value. The FUND may terminate an option that it has written prior to its expiration by entering into a closing purchase transaction in which it purchases an option having the same terms as the option written. The FUND will realize a profit or loss from such transaction if the cost of such transaction is less or more, respectively, than the premium received from the writing of the option. In the case of a put option, any loss so incurred may be partially or entirely offset by the premium received from a simultaneous or subsequent sale of a different put option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from the repurchase of a call option is likely to be offset in whole or in part by unrealized appreciation of the underlying security owned by the FUND. Purchasing Put and Call Options on Securities The FUND may purchase put options to protect its portfolio holdings in an underlying security against a decline in market value. Such hedge protection is provided during the life of the put option since the FUND, as holder of the put option, is able to sell the underlying security at the put exercise price regardless of any decline in the underlying security's market price. In order for a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs. By using put options in this manner, the FUND will reduce any profit it might otherwise have realized in the underlying security by the premium paid for the put option and by transaction costs. The FUND may also purchase call options to hedge against an increase in prices of securities that it wants ultimately to buy. Such hedge protection is provided during the life of the call option since the FUND, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, the FUND will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by transaction costs. -3- Purchase and Sale of Options and Futures on Stock Indices The FUND may purchase and sell options on stock indices and stock index futures as a hedge against movements in the equity markets. Options on stock indices are similar to options on specific securities except that, rather than the right to take or make delivery of the specific security at a specific price, an option on a stock index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of that stock index is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing price of the index and the exercise price of the option expressed in dollars multiplied by a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on specific securities, all settlements of options on stock indices are in cash and gain or loss depends on general movements in the stocks included in the index rather than price movements in particular stocks. Currently, index options traded include the S&P 100 Index, the S&P 500 Index, the NYSE Composite Index, the AMEX Market Value Index, the National Over-the-Counter Index and other standard broadly based stock market indices. A stock index futures contract is an agreement in which one party agrees to deliver to the other an amount of cash equal to a specific dollar amount multiplied by the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made. If the Portfolio Manager expects general stock market prices to rise, it might purchase a call option on a stock index or a futures contract on that index as a hedge against an increase in prices of particular equity securities it wants ultimately to buy. If in fact the stock index does rise, the price of the particular equity securities intended to be purchased may also increase, but that increase would be offset in part by the increase in the value of the FUND's index option or futures contract resulting from the increase in the index. If, on the other hand, the Portfolio Manager expects general stock market prices to decline, it might purchase a put option or sell a futures contract on the index. If that index does in fact decline, the value of some or all of the equity securities in the FUND's portfolio may also be expected to decline, but that decrease would be offset in part by the increase in the value of the FUND's position in such put option or futures contract. Purchase and Sale of Interest Rate Futures The FUND may purchase and sell interest rate futures contracts on U.S. Treasury bills, notes and bonds for the purpose of hedging fixed income and interest sensitive securities against the adverse effects of anticipated movements in interest rates. The FUND may sell interest rate futures contracts in anticipation of an increase in the general level of interest rates. Generally, as interest rates rise, the market value of the fixed income securities held by the FUND will fall, thus reducing the net asset value of the FUND. This interest rate risk can be reduced without employing futures as a hedge by selling long-term fixed income securities and either reinvesting the proceeds in securities with shorter maturities or by holding assets in cash. This strategy, however, entails increased transaction costs to the FUND in the form of dealer spreads and brokerage commissions. The sale of interest rate futures contracts provides an alternative means of hedging against rising interest rates. As rates increase, the value of the FUND's short position in the futures contracts will also tend to increase, thus offsetting all or a portion of the depreciation in the market value of the FUND's investments which are being hedged. While the FUND will incur commission expenses in selling and closing out futures positions (which is done by taking an opposite position which operates to terminate the position in the futures contract), commissions on futures transactions are lower than transaction costs incurred in the purchase and sale of portfolio securities. -4- Options on Stock Index Futures Contracts and Interest Rate Futures Contracts The FUND may purchase and write call and put options on stock index and interest rate futures contracts. The FUND may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or stock indices or purchasing and selling the underlying futures. For example, the FUND may purchase put options or write call options on stock index futures or interest rate futures, rather than selling futures contracts, in anticipation of a decline in general stock market prices or rise in interest rates, respectively, or purchase call options or write put options on stock index or interest rate futures, rather than purchasing such futures, to hedge against possible increases in the price of equity securities or debt securities, respectively, which the FUND intends to purchase. Purchase and Sale of Currency Futures Contracts and Related Options In order to hedge its portfolio and to protect it against possible variations in foreign exchange rates pending the settlement of securities transactions, the FUND may buy or sell foreign currencies or may deal in forward currency contracts. The FUND may also invest in currency futures contracts and related options. If a decline in exchange rates for a particular currency is anticipated, the FUND may sell a currency futures contract or a call option thereon or purchase a put option on such futures contract as a hedge. If it is anticipated that exchange rates will rise, the FUND may purchase a currency futures contract or a call option thereon or sell (write) a put option to protect against an increase in the price of securities denominated in a particular currency the FUND intends to purchase. These futures contracts and related options thereon will be used only as a hedge against anticipated currency rate changes, and all options on currency futures written by the FUND will be covered. A currency futures contract sale creates an obligation by the FUND, as seller, to deliver the amount of currency called for in the contract at a specified future time for a specified price. A currency futures contract purchase creates an obligation by the FUND, as purchaser, to take delivery of an amount of currency at a specified future time at a specified price. Although the terms of currency futures contracts specify actual delivery or receipt, in most instances the contracts are closed out before the settlement date without the making or taking of delivery of the currency. Closing out of a currency futures contract is effected by entering into an offsetting purchase or sale transaction. Unlike a currency futures contract, which requires the parties to buy and sell currency on a set date, an option on a currency futures contract entitles its holder to decide on or before a future date whether to enter into such a contract or let the option expire. The FUND will write (sell) only covered put and call options on currency futures. This means that the FUND will provide for its obligations upon exercise of the option by segregating sufficient cash or short-term obligations or by holding an offsetting position in the option or underlying currency future, or a combination of the foregoing. The FUND will, so long as it is obligated as the writer of a call option on currency futures, own on a contract-for-contract basis an equal long position in currency futures with the same delivery date or a call option on stock index futures with the difference, if any, between the market value of the call written and the market value of the call or long currency futures purchased maintained by the FUND in cash, Treasury bills, or other high-grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the call purchased by the FUND falls below 100% of the market value of the call written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high grade short-term obligations equal in value to the difference. Alternatively, the FUND may cover the call option through segregating with the custodian an amount of the particular foreign currency equal to the amount of foreign currency per futures contract option multiplied by the number of options written by the FUND. In the case of put options on currency futures written by the FUND, the FUND will hold the aggregate exercise price in cash, Treasury bills, or other high grade short-term obligations in a segregated account with its custodian, or own put options on currency futures or short currency futures, with the difference, if any, between the market value of the put written and the market value of the puts purchased or the currency futures sold maintained by the FUND in cash, Treasury bills or other high grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the put options purchased or the currency futures sold by the FUND falls -5- below 100% of the market value of the put options written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high grade short-term obligations equal in value to the difference. If other methods of providing appropriate cover are developed, the FUND reserves the right to employ them to the extent consistent with applicable regulatory and exchange requirements. In connection with transactions in stock index options, stock index futures, interest rate futures, foreign currency futures and related options on such futures, the FUND will be required to deposit as "initial margin" an amount of cash and short-term U.S. Government securities equal to from 5% to 10% of the contract amount. Thereafter, subsequent payments (referred to as "variation margin") are made to and from the broker to reflect changes in the value of the futures contract. Forward Foreign Currency Exchange Contracts The value of the FUND's assets as measured in U.S. dollars may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the FUND may incur costs in connection with conversions between various currencies. The 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. A forward foreign currency exchange contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties at a price set at the time of the contract. These contracts are traded directly or indirectly between currency traders (usually large commercial banks) and their customers. While the pursuit of foreign currency gain is not a primary objective of the FUND, the FUND may, from time to time, hold foreign currency to realize such gains. (These gains constitute non-qualifying income that is subject to the 10% limitation with respect to the "Income Requirement" of Subchapter M of the Internal Revenue Code of 1986, as amended, which is discussed herein under "Dividends, Capital Gains Distributions and Tax Matters.") The FUND will enter into forward foreign currency exchange contracts as described hereafter. When the FUND enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to establish the U.S. dollar cost or proceeds. By entering into a forward contract in U.S. dollars for the purchase or sale of the amount of foreign currency involved in an underlying security transaction, the FUND will be able to protect itself against a possible loss between trade and settlement dates resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. However, this tends to limit potential gains which might result from a positive change in such currency relationships. When the Portfolio Manager believes that the currency of a particular foreign country may suffer a substantial decline against the U.S. dollar, it may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of the FUND's portfolio securities denominated in such foreign currency. The forecasting of short-term currency market movement is extremely difficult and the successful execution of a short-term hedging strategy is highly uncertain. The FUND does not intend to enter into such forward contracts on a regular or continuous basis, and will not do so if, as a result, the FUND would have more than 25% of the value of its total assets committed to such contracts. The FUND will also not enter into such forward contracts or maintain a net exposure in such contracts where the FUND would be obligated to deliver an amount of foreign currency in excess of the value of the FUND's portfolio securities or other assets denominated in that currency. Under normal circumstances, consideration of the prospect for currency parities will be incorporated into the longer term investment decisions made with regard to overall strategies. However, the Trustees of the FUND believe that it is important to have the flexibility to enter into such forward contracts when the Portfolio Manager determines that the best interests of the FUND will be served. The FUND's custodian bank will segregate cash or marketable high grade debt securities in an amount not less than the value of the FUND's total assets committed to foreign currency exchange contracts entered into under this type of transaction. If the value of the securities segregated declines, additional cash or securities will be added on a daily basis, i.e., -6- marked-to-market, so that the segregated amount will not be less than the amount of the FUND's commitments with respect to such contracts. Generally, the FUND will not enter into a forward foreign currency exchange contract with a term of greater than one year. At the maturity of the contract, the FUND may either sell the portfolio security and make delivery of the foreign currency, or may retain the security and terminate the obligation to deliver the foreign currency by purchasing an "offsetting" forward contract with the same currency trader obligating the FUND to purchase, on the same maturity date, the same amount of foreign currency. It is impossible to forecast with absolute precision the market value of portfolio securities at the expiration of the contract. Accordingly, it may be necessary for the FUND to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security is less than the amount of foreign currency the FUND is obligated to deliver and if a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security if its market value exceeds the amount of foreign currency the FUND is obligated to deliver. If the FUND retains the portfolio security and engages in an offsetting transaction, the FUND will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the FUND engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline during the period between entering into a forward contract for the sale of a foreign currency and the date the FUND enters into an offsetting contract for the purchase of the foreign currency, the FUND will realize a gain to the extent the price of the currency the FUND has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the FUND will suffer a loss to the extent the price of the currency the FUND has agreed to purchase exceeds the price of the currency the FUND has agreed to sell. The FUND's dealing in forward foreign currency exchange contracts will be limited to the transactions described above. Of course, the FUND is not required to enter into such transactions with regard to its foreign currency-denominated securities and will not do so unless deemed appropriate by the Portfolio Manager. It also should be realized that this method of protecting the value of the FUND's portfolio securities against the decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange which one can achieve at some future point in time. Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time they tend to limit any potential gain which might result should the value of such currency increase. Additional Risks of Futures Contracts and Related Options and Forward Foreign Currency Exchange Contracts The market prices of futures contracts may be affected by certain factors. First, all participants in the futures market are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the securities and futures markets. Second, from the point of view of speculators, the deposit requirements in the futures market are less onerous than margin requirements in the securities market. Therefore, increased participation by speculators in the futures market may also cause temporary price distortions. In addition, futures contracts in which the FUND may invest may be subject to commodity exchange imposed limitations on fluctuations in futures contract prices during a single day. Such regulations are referred to as "daily price fluctuation limits or daily limits". During a single trading day no trades may be executed at prices beyond the daily limit. Once the price of a futures contract has increased or decreased by an amount equal to the daily limit, positions in those futures cannot be taken or liquidated unless both a buyer and seller are willing to effect trades at or within the limit. Daily limits, or regulatory intervention in the commodity -7- markets, could prevent the FUND from promptly liquidating unfavorable positions and adversely affect operations and profitability. Forward foreign currency exchange contracts ("forward contracts") are not traded on contract markets regulated by the Commodity Futures Trading Commission ("CFTC") and are not regulated by the SEC. Rather, forward contracts are traded through financial institutions acting as market-makers. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. In addition, futures contracts and related options, and forward contracts may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Ratings of Debt Instruments The four highest ratings of Moody's Investors Service, Inc. ("Moody's") for U.S. corporate and municipal bonds are Aaa, Aa, A and Baa. Bonds rated Aaa are judged by Moody's to be of the best quality. Bonds 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. Moody's states that Aa bonds are rated lower than the best bonds because margins of protection or other elements make their long-term risks appear somewhat larger than the long-term risks for Aaa bonds. Bonds which are rated A by Moody's possess many favorable investment attributes and are considered "upper medium grade obligations." Factors giving security to principal and interest of A rated bonds are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Bonds that are rated Baa 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 have speculative characteristics as well. The four highest ratings of Standard & Poor's Corporation ("S&P") for U.S. bonds are AAA, AA, A and BBB. Bonds rated AAA have the highest rating assigned by S&P to an obligation. Capacity to pay interest and repay principal is extremely strong. Bonds rated AA have a very strong capacity to pay interest and repay principal and differ from the highest rated issues only in a small degree. Bonds rated A have a strong capacity to pay principal and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. Bonds rated BBB are considered on the borderline between definitely sound obligations and obligations where the speculative element begins to predominate. Ratings of Commercial Paper Commercial paper rated A-1 by S&P has the following characteristics: liquidity ratios are adequate to meet cash requirements; the issuer has access to at least two additional channels of borrowing; basic earnings and cash flow have an upward trend with allowance made for unusual circumstances; the issuer's industry is well established and the issuer has a strong position within the industry and the reliability and quality of management are unquestioned. Relative strength or weakness of the above factors determines whether the issuer's commercial paper is rated A-1, A-2 or A-3. The rating P-1 is the highest commercial paper rating assigned by Moody's. Among the factors considered by Moody's in assigning ratings are the following: (1) evaluation of the management of the issuer; (2) -8- economic evaluation of the issuer's industry or industries and an appraisal of speculative-type risks which may be inherent in certain areas; (3) evaluation of the issuer's products in relation to competition and customer acceptance; (4) liquidity; (5) amount and quality of long-term debt; (6) trend of earnings over a period of ten years; (7) financial strength of a parent company and the relationships which exist with the issuer; and (8) recognition by the management of obligations which may be present or may arise as a result of public interest questions and preparations to meet such obligations. Regulatory Matters In connection with its proposed futures and options transactions, the FUND has filed with the Commodity Futures Trading Commission ("CFTC") a notice of eligibility for exemption from the definition of (and therefore from CFTC regulation as) a "commodity pool operator" under the Commodity Exchange Act. The FUND has represented in its notice of eligibility that: (i) it will not purchase or sell futures or options on futures contracts or stock indices if as a result the sum of the initial margin deposits on its existing futures contracts and related options positions and premiums paid for options on futures contracts or stock indices would exceed 5% of the FUND's assets; and (ii) with respect to each futures contract purchased or long position in an option contract, the FUND will set aside in a segregated account cash or cash equivalents in an amount equal to the market value of such contracts less the initial margin deposit. The Staff of the SEC has taken the position that the purchase and sale of futures contracts and the writing of related options may involve senior securities for the purposes of the restrictions contained in Section 18 of the Investment Company Act of 1940 (the "1940 Act") on investment companies issuing senior securities. However, the staff has issued letters declaring that it will not recommend enforcement action under Section 18 if an investment company: (i) sells futures contracts to offset expected declines in the value of the investment company's portfolio securities, provided the value of such futures contracts does not exceed the total market value of those securities (plus such additional amount as may be necessary because of differences in the volatility factor of the portfolio securities vis-a-vis the futures contracts); (ii) writes call options on futures contracts, stock indexes or other securities, provided that such options are covered by the investment company's holding of a corresponding long futures position, by its ownership of portfolio securities which correlate with the underlying stock index or otherwise; (iii) purchases futures contracts, provided the investment company establishes a segregated account ("cash segregated account") consisting of cash or cash equivalents in an amount equal to the total market value of such futures contracts less the initial margin deposited therefor; and (iv) writes put options on futures contracts, stock indices or other securities, provided that such options are covered by the investment company's holding of a corresponding short futures position, by establishing a cash segregated account in an amount equal to the value of its obligation under the option, or otherwise. The FUND will conduct its purchases and sales of futures contracts and writing of related options transactions in accordance with the foregoing. -9- Additional Information Regarding Precious Metals and Precious Metals Securities The production and marketing of gold and precious metals may be affected by the action of certain governments and changes in existing governments. For example, the mining of gold is highly concentrated in a few countries. In current order of magnitude of production of gold bullion, the five largest producers of gold are the Republic of South Africa, the Union of Soviet Socialist Republics, Canada, Brazil and the United States. Economic and political conditions prevailing in these countries may have a direct effect on the production and marketing of newly produced gold and sales of central bank gold holdings. It is expected that a majority of gold mining companies in which the FUND will invest will be located within the United States and Canada. Prices of Precious Metals Securities can be volatile and tend to experience greater volatility than the prices of physical precious metals. This is due to the fact that the costs of mining precious metals remain relatively fixed, so that an increase or decrease in the price of precious metals has a direct and greater than proportional effect on the profitability of precious metals mining companies. Investments tied to precious metals characteristically involve high risk because of precious metals' price volatility. The price of precious metals is affected by factors such as cyclical economic conditions, political events and monetary policies of various countries. During periods of rising precious metals prices, the FUND will tend to emphasize investments in Precious Metals Securities. Portfolio Turnover As a result of its investment policies, the FUND expects to engage in a substantial number of portfolio transactions. However, the FUND's portfolio turnover rate is not expected to exceed 100%. A 100% portfolio turnover rate would occur if 100% of the securities owned by the FUND were sold and either repurchased or replaced by it within one year. The FUND's portfolio turnover rate is, generally, the percentage computed by dividing the lesser of FUND's purchases or sales exclusive of short-term securities and bullion, by the average value of the FUND's total investments exclusive of short-term securities and bullion. The portfolio turnover rates for the fiscal years ended April 30, 1995 and 1994, were 116% and 174%, respectively. High portfolio turnover involves correspondingly greater brokerage commissions, other transaction costs, and a possible increase in short-term capital gains or losses. Shareholders are taxed on any such net gains at ordinary income rate. INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means respectively the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions. 1. As a non-diversified management investment company, the FUND has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having as few as twelve issuers. -10- 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) 25% or more of its total assets would be concentrated in companies within any one industry except the FUND may invest 25% or more of its assets in Precious Metals Securities as defined in the Prospectus and (d) more than 5% of total assets would be invested in warrants or rights or invest more than 2% of its total assets if such warrants are not listed on the New York Stock Exchange. 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 10% of the market value of its total assets). The FUND will not purchase securities while borrowing is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities other than (a) through the purchase of publicly distributed debt securities in accordance with its investment objective and (b) through repurchase agreements. 5. The FUND may not invest more than 10% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities. 6. The FUND may not knowingly purchase or otherwise acquire securities which are subject to legal or contractual restrictions on resale or for which there is no readily available market if, as a result thereof, more than 10% of the assets of the FUND (taken at market value) would be invested in such securities, including repurchase agreements with maturity dates in excess of 7 days. 7. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 8. The FUND may not purchase or sell commodity contracts, except for futures contracts and related options as described under "Investment Objective and Policies" in the Prospectus and this Statement of Additional Information. 9. The FUND may not buy any securities or other property on margin (except for options and futures trading and for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 10. The FUND may not invest in companies for the purpose of exercising control or management. 11. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter in the resale of any portfolio securities. 12. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Directors of the FUND and the officers and directors of VCM, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 13. The FUND may not purchase or sell real estate (although it may purchase securities secured by real estate interests or interests therein, or issued by companies or investment trusts which invest in real estate or interests therein). -11- 14. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs; provided, however, that if consistent with the objectives of the FUND, the FUND may purchase securities of issuers whose principal business activities fall within such areas. 15. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The net asset value per share is computed by dividing the value of all securities plus other assets, less liabilities, by the number of shares outstanding. Each determination of the FUND's net asset value is made (i) by valuing portfolio securities which are traded on the New York Stock Exchange or the American Stock Exchange at the last sale price, or, if no sale, at the closing bid price, (ii) by valuing other securities as nearly as possible in the manner described in clause (i) if traded on any other U.S. or foreign exchange, and, if not so traded, on the basis of the latest available bid prices. A security which is listed or traded on more than one exchange, is valued at the quotation on the exchange determined to be the primary market for such security by the Board of Directors or VCM. High-quality short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less, or by amortizing their value on the 61st day prior to maturity if their original term to maturity exceeded 60 days. Amortized cost will be used unless the Board of Directors determines that such method does not represent fair value. Generally, trading in foreign securities, as well as trading in corporate bonds, U.S. government securities and money market instruments, is substantially completed each day at various times prior to the close of the New York Stock Exchange. The values of such securities used in computing the net asset value of the FUND are determined as of such times. Foreign currency exchange rates are also generally determined prior to 4:15 p.m. Bullion investments are valued at the closing spot price based on dealer or exchange quotations. Occasionally, events affecting the value of metal securities may occur between such times and 4:15 p.m. which will not be reflected in the computation of the FUND's net asset value. If events occur which materially affect the value of metal securities, the securities will be valued at fair value as determined in good faith by the Board of Directors. Puts and calls held by the FUND are valued at the last sales price or, if there are no transactions, at the mean between the closing bid and asked prices. When the FUND writes a call, an amount equal to the premium received is included in the FUND's statement of assets and liabilities as an asset, and an equivalent credit is included in the liability section. The credit is "marked-to-market" to reflect the current market value of the call. If a call expires, the FUND has a gain in the amount of the premium received; if the FUND enters into a closing purchase transaction, it will have a gain or loss depending on whether the premium received was more or less than the cost of the closing transaction. All other securities and other assets of the FUND are valued at fair value as determined in good faith by the Board of Directors. -12- PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to shareholders, performance will be stated in terms of total return, rather than in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the SEC, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula, the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's average annual total return figures, reflecting the initial investment and reinvestment of all dividends and distributions, net of the pro rata share of the account opening fee, for the one and five year periods and the life of fund (June 22, 1988 to April 30, 1995) ended April 30, 1995 were -4.39%, 5.79% and .87%, respectively. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or the Standard & Poor's 500 Stock Index or the Dow Jones Industrial Average, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment dates. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee which was in effect until December 1994 from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under SEC rules and all advertisements containing performance data will include a legend disclosing that such performance data represent past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. -13- PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Manager subject to the supervision of VCM and the Board of Directors and pursuant to authority contained in the Investment Advisory Contract and Sub-Advisory Agreements between the FUND and VCM, and VCM and the Portfolio Manager. In selecting such brokers or dealers, the Portfolio Manager will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, and financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to the Portfolio Manager for the FUND's use, which in the opinion of the Board of Directors are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to the Portfolio Manager. Such allocation shall be in such amounts as VCM shall determine and the Portfolio Manager shall report regularly to VCM who will in turn report to the Board of Directors on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to the Portfolio Manager in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of the Portfolio Manager's other clients may be useful to the Portfolio Manager in carrying out its obligations to the FUND. The receipt of such research may not reduce the Portfolio Manager's normal independent research activities. The Portfolio Manager is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and the Portfolio Manager or their affiliated broker-dealers on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from brokerage commissions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the management fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between VCM and the Portfolio Manager does not provide for any reduction in the advisory fees as a result of profits resulting from brokerage commissions effected through the Portfolio Manager or any affiliated brokerage firms. For the years ended April 30, 1995, 1994, and 1993 the FUND incurred brokerage commission expenses of $395,000, $654,000, and $190,954, respectively from the purchase and sale of portfolio securities. The Board of Directors had adopted certain procedures incorporating the standards of Rule 17e-1 issued under the Investment Company Act of 1940 (the "1940 Act") which requires that the commissions paid the Distributor or to the Portfolio Manager or to their affiliated broker-dealers must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Directors and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commission which other brokers or dealers would have charged -14- for effecting such transactions provided the Portfolio Manager determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. It may happen that the same security will be held by other clients of VCM or of the Portfolio Manager. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better execution results for the FUND. DIVIDENDS, CAPITAL GAINS DISTRIBUTIONS AND TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. If the FUND has a net capital loss (i.e., the excess of capital losses over capital gains) for any year, the amount thereof may be carried forward up to eight years and treated as a short-term capital loss which can be used to offset capital gains in such years. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short -15- Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the Fund at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Section 1256, will generally be treated as ordinary income or loss. In general, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts, certain foreign currency contracts and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss (except for Section 1256 forward foreign currency contracts, which are subject to the Section 988 Rules). The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service has held in several private rulings that gains arising from Section 1256 contracts will be treated for purposes of the -16- Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The FUND may purchase securities of certain foreign investment funds or trusts which constitute passive foreign investment companies ("PFICs") for federal income tax purposes. If the FUND invests in a PFIC, it may elect to treat the PFIC as a qualifying electing fund (a "QEF") in which event the FUND will each year have ordinary income equal to its pro rata share of the PFIC's ordinary earnings for the year and long-term capital gain equal to its pro rata share of the PFIC's net capital gain for the year, regardless of whether the FUND receives distributions of any such ordinary earnings or net capital gain from the PFIC. If the FUND does not (because it is unable to, chooses not to or otherwise) elect to treat the PFIC as a QEF, then in general (i) any gain recognized by the FUND upon a sale or other disposition of its interest in the PFIC or any "excess distribution" (as defined) received by the FUND from the PFIC will be allocated ratably over the FUND's holding period of its interest in the PFIC, (ii) the portion of such gain or excess distribution so allocated to the year in which the gain is recognized or the excess distribution is received shall be included in the FUND's gross income for such year as ordinary income (and the distribution of such portion by the FUND to shareholders will be taxable as an ordinary income dividend, but such portion will not be subject to tax at the FUND level), (iii) the FUND shall be liable for tax on the portions of such gain or excess distribution so allocated to prior years in an amount equal to, for each such prior year, (A) the amount of gain or excess distribution allocated to such prior year multiplied by the highest corporate tax rate in effect for such prior year plus (B) interest on the amount determined under clause (A) for the period from the due date for filing a return for such prior year until the date for filing a return for the year in which the gain is recognized or the excess distribution is received at the rates and methods applicable to underpayments of tax for such period, and (iv) the distribution by the FUND to shareholders of the portions of such gain or excess distribution so allocated to prior years (net of the tax payable by the FUND thereon) will again be taxable to the shareholders as an ordinary income dividend. Under recently proposed Treasury Regulations a Fund can elect to recognize as gain the excess, as of the last day of its taxable year, of the fair market value of each share of PFIC stock over the Fund's adjusted tax basis in that share ("mark to market gain"). Such mark to market gain will be included by the Fund as ordinary income, such gain will not be subject to the Short-Short Gain Test, and the Fund's holding period with respect to such PFIC stock commences on the first day of the next taxable year. If the Fund makes such election in the first taxable year it holds PFIC stock, the Fund will include ordinary income from any mark to market gain, if any, and will not incur the tax described in the previous paragraph. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. In addition to satisfying the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. However, with regard to forward currency contracts, there does not appear to be any formal or informal authority which identifies the issuer of such instrument. -17- Although the FUND's management and the Portfolio Manager will endeavor to manage the FUND's portfolio so that the FUND's investment in Physical Precious Metals Investments (as defined in the Prospectus) does not result in its failure to satisfy the asset diversification test or the source of income requirement described above, the FUND's management reserves the right to depart from this policy whenever, in its sole judgment, it is deemed in the best interests of the FUND and its shareholders to do so. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. According to an Internal Revenue Service announcement of Treasury regulations to be promulgated, if the FUND qualifies and elects to be taxed as a regulated investment company after not qualifying as a regulated investment company for more than one year, the FUND will be subject to federal income tax on the amount of the net unrealized gain on its assets at the time of requalification (or, if the FUND so elects, at the time such net unrealized gain is recognized during the following ten year period). Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. Fund Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they will qualify for the 70% dividends-received deduction for corporations only to the extent discussed below. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend it will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his or her shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. -18- Ordinary income dividends paid by the FUND with respect to a taxable year will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as "S" corporations, which are not eligible for the deduction because of their special characteristics and other than for purposes of special taxes such as the accumulated earnings tax and the personal holding company tax) to the extent of the amount of qualifying dividends received by the FUND from domestic corporations for the taxable year. A dividend received by the FUND will not be treated as a qualifying dividend (1) if it has been received with respect to any share of stock that the FUND has held for less than 46 days (91 days in the case of certain preferred stock), excluding for this purpose under the rules of Code Section 246(c)(3) and (4): (i) any day more than 45 days (or 90 days in the case of certain preferred stock) after the date on which the stock becomes ex-dividend and (ii) any period during which the FUND has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such (or substantially identical) stock; (2) to the extent that the FUND is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property; or (3) to the extent the stock on which the dividend is paid is treated as debt-financed under the rules of Code Section 246A. Moreover, the dividends- received deduction for a corporate shareholder may be disallowed or reduced (i) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the FUND or (ii) by application of Code Section 246(b) which in general limits the dividends-received deduction to 70% of the shareholder's taxable income (determined without regard to the dividends-received deduction and certain other items). Alternative Minimum Tax ("AMT") is imposed in addition to, but only to the extent it exceeds, the regular tax and is computed at the rate of 26% (or 28%, for taxable income in excess of $175,000) for noncorporate taxpayers and 20% for corporate taxpayers on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. The corporate dividends received deduction is not itself an item of tax preference that must be added back to taxable income or is otherwise disallowed in determining a corporation's AMTI. However, corporate shareholders will generally be required to take the full amount of any dividend received from the FUND into account (without a dividends-received deduction) in determining its adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consists of the stock or securities of foreign corporations, the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid his pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not -19- itemize deductions. Each shareholder should consult his own tax advisor regarding the potential application of foreign tax credits. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U. S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (discussed above in connection with the dividends-received deduction for corporations) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. -20- If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. -21- THE MANAGEMENT OF THE FUND Officers and Directors are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Director of the Fund; Chairman and Trustee of Blanchard Funds; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, -22- PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Director and Treasurer of the Fund; President, Trustee and Treasurer of Blanchard Funds; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. -23- Peter E. Madden, 53 225 Franklin Street Boston, MA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. -24- Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Director of the Fund; Trustee of Blanchard Funds; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Director is deemed to be an "interested person" of the Fund as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Directors handles the responsibilities of the Board of Directors between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process. The Funds As referred to in the list of Directors and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of July 31, 1995, Officers and Directors own less than 1% of the outstanding shares of each Fund. -25- To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. Officers and Directors Compensation - ------------------------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - ------------------------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Director Thomas G. Bigley, Director $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Director $-0- $2,001.50 for the Fund Complex William J. Copeland, Director $-0- $2,001.50 for the Fund Complex James E. Dowd, Director $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Director Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Director Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Director Peter E. Madden, Director $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Director $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Director Wesley W. Posvar, Director $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Director * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
MANAGEMENT SERVICES Manager to the Fund The Fund's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments -26- are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Fund, or any shareholder of any 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 Fund. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the fiscal years ended April 30, 1995, 1994 and 1993, the aggregate amounts paid or accrued by the Fund to the prior manager under the then existing management agreement were $756,766, $602,610 and $227,978, respectively. The prior manager was not required to reimburse the Fund for any expenses during the years ended April 30, 1995, 1994 and 1993. PORTFOLIO MANAGEMENT SERVICES Pursuant to a sub-advisory agreement (the "Sub-Advisory Agreement") between VCM and the portfolio manager, Cavelti Capital Management, Ltd. (the "Portfolio Manager"), VCM has delegated to the Portfolio Manager the authority and responsibility to make and execute decisions for the Fund within the framework of the Fund's investment policies, subject to review by VCM and the Board of Directors of the Fund. Under the terms of the Sub-Advisory Agreement, the Portfolio Manager has discretion to purchase and sell securities, except as limited by the Fund's investment objective, policies and restrictions. The Sub-Advisory Agreement provides for the payment to the Portfolio Manager, by VCM, of monthly compensation based on the Fund's average daily net assets for providing investment advice to the Fund and managing the investment of the assets of the Fund. These fees are determined by applying the following annual rates to the Fund's average daily net assets: .30% of the Fund's net assets up to the first $150 million; .2625% of the Fund's net assets in excess of $150 million but less than $300 million; and .225% of the Fund's net assets in excess of $300 million. The Agreement provides that the Portfolio Manager's fee shall be reduced proportionately based on the ratio of the Portfolio Manager's fee to VCM's fee in the event VCM's fee is reduced as a result of a state expense limitation. For the fiscal years ended April 30, 1995, 1994 and 1993, the aggregate amounts paid or accrued by the prior manager to the Portfolio Manager under the Sub-Advisory Agreement were $227,033, $170,058, and $95,907, respectively. The Sub-Advisory Agreement, dated July 11, 1995, was approved by the Fund's Directors on March 24, 1995 and the Fund's shareholders on July 11, 1995. The Sub-Advisory Agreement provides that it may be terminated without penalty by either the Fund or the Portfolio Manager at any time by the giving of 60 days' written notice to the other and terminates automatically in the event of "assignment", as defined in the Investment Company Act. The Sub-Advisory Agreement provides that, unless sooner terminated, it shall continue in effect from year to year only so long as such continuance is specifically approved at least annually by either the Board of Directors of the Fund or by a vote of the majority of the outstanding voting securities of the Fund, provided, that in either event, such continuance is also approved by the vote of the majority of the Directors who are not parties to the Sub-Advisory Agreement or "interested persons" of such parties cast in person at a meeting called for the purpose of voting on such approval. -27- ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Fund has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Director reasonably requests. For the fiscal year ended April 30, 1995, the FUND accrued payments under the Plan amounting to $567,575. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Directors expected 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 in shares 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. DESCRIPTION OF THE FUND The FUND is a Maryland corporation. The FUND's authorized shares consists of 1,000,000,000 shares of common stock, par value $.001 per share. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights, the right of redemption and the privilege of exchange are described in the Prospectus. Shares are fully paid and non-assessable. The FUND may be terminated upon the sale of its assets to another open-end management investment company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specifically allocated to the FUND, and constitute the underlying assets of the FUND. -28- SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. -29- Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Precious Metals Fund for the fiscal year ending April 30, 1995. Morningstar has ranked the Fund 8th out of the 26 funds in its precious metals category, based on total reinvested performance, for the 5 years ending 4/30/95. Naturally, past performance is no guarantee of future performance. As with all mutual funds, principal value and return will vary with market conditions so that shares, when redeemed, may be worth more or less than their original cost. The Year In Review We started the year fully invested, but with almost one third of the portfolio in gold and silver bullion _ an unusual asset mix for the fund. This positioning reflected our view that a more defensive stance was warranted while the U.S. Federal Reserve was raising interest rates. With the likelihood that gold might be stuck in a trad ing range below $400 for some months, it seemed quite likely that bullion would outperform gold mining shares. This proved to be the case as gold shares grew increasingly out of favor as the year progressed. For the past year, gold has essentially marked time by swinging back and forth between the $370 and $400 levels. If an interest rate hike was anticipated, gold would move lower in advance of the hike. After the rate change occurred, gold would rally back towards the top of the trading range until convictions grew that rates would be raised again. All in all, a difficult environment for gold share investors. In 1995, a new element was added to the gold market dynamics _ a rapidly devaluing U.S. dollar. Many investors were confused and disappointed by the failure of gold to soar during this period. This is understandable because, on the surface, a dollar devaluation is bullish for gold. However, the linkage is often quite weak. Clearly, this was one of those times, as the value of gold priced in non-dollar terms fell quite sharply. The sober conclusion is that the gold market viewed the outcome of the dollar crisis as (over, please) The following information was represented as a line graph - -------------------------------------------------------------------------------- The Value of a $10,000 Investment in the Blanchard Precious Metals Fund from inception 6/23/88 through 4/30/95 as compared to the Toronto Stock Exchange Gold & Silver Index for the same period ----------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Precious Metals Fund* ----------------------------------- 1 year -4.39% ----------------------------------- 5 year 5.79% ----------------------------------- since inception 0.87% -----------------------------------
FYE 4/30/89 FYE 4/30/90 FYE 4/30/91 FYE 4/30/92 FYE 4/30/93 FYE 4/30/94 FYE 4/30/95 RMF -10.20% -10.90% -16.00% -4.70% 35.50% 27.80% -4.39% TSE G&S IDX -16.19% 8.65% -17.22% -11.28% 74.98% 24.82% 4.11% $9,925 $8,913 $7,941 $6,671 $6,357 $8,614 $11,008 $10,525 $10,000 $8,381 $9,106 $7,538 $6,688 $11,702 $14,606 $15,207
Blanchard Toronto Stock Precious Metals Exchange Gold & Fund* Silver Index (D) *The average annual returns quoted above do not reflect the deduction of the account opening fee and assume reinvestment of distributions. If fee was reflected, returns would be lower. Total return includes changes in principal value. Average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: The Toronto Stock Exchange Gold & Silver Index is an unmanaged index of the stock performance of companies engaged in gold and silver mining activities. ^Reflects the deduction of the one-time-only $75 account opening fee. This chart is for comparative purposes only and is not intended to reflect future performance of the index or the BPMF. - -------------------------------------------------------------------------------- deflationary. Certainly, for exporting nations like Germany and Japan, the strong rise in their currencies is deflationary. For the U.S., dollar weakness is another inflationary strain that could prompt the Federal Reserve to tighten monetary policy when it otherwise wouldn't. A Look Ahead Fortunately, there have recently been two important changes in the global investment scene which underpin the bullish commodity fundamentals for gold and which alleviate the deflationary pressure. First, the central banks of Germany and Japan have cut domestic interest rates. Secondly, U.S. monetary policy has shifted into neutral from the steady tightening experienced in 1994. In fact, there are some who argue that the U.S. should now cut rates in response to an obvious softening in the economy. We believe gold would shoot through the $400 level decisively if this pleasant scenario were to unfold. We note that gold rose from the $381 level to the $400 level in just two days after the German central bank cut rates in late March! The commodity supply-demand picture for gold continues to remain quite bullish. On the supply side, global gold production is now in decline for the first time in twenty years. Moreover, labor productivity problems in South Africa virtually ensure that global output will contract again in 1995. South African gold output is now at the lowest level since 1958. Last year's production was 584 tonnes, and we look for a further slide to about 540 tonnes in 1995. Demand in 1994 was steady at near-record levels, and only huge disinvestment of about 500,000 ounces per month kept the price from rising. With physical demand now accelerating sharply outside of North America, we estimate that net disinvestment of about one million ounces per month is required to prevent gold from rising. How likely is this to continue? Given the increased volatility in currency markets and the more favorable monetary conditions, we think it much less likely that investors will be willing to part with their gold below the $400 level. From this perspective, the next upleg in the bull market in gold may lie just ahead of us! In anticipation of improving gold prices, the Fund's portfolio is once again in an aggressive posture. A 5% weighting in silver is our only bullion position, and cash levels are being kept near 3% while 92% of the portfolio is invested in gold mining equities. We have also increased our exposure to junior producers, favoring those companies which are already in production, yet have a number of years of solid growth ahead of them. Sincerely, PC:ml Peter C. Cavelti President Cavelti Capital Management Portfolio Manager of the Blanchard Precious Metals Fund Distributed by Sheffield Investments, Inc. (1551) 01ARSL0695 BLANCHARD PRECIOUS METALS FUND, INC.-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Shares Value ------ ----- COMMON STOCKS (83.12%) METAL MINING SECURITIES (83.12%) AUSTRALIA (5.75%) *Great Central Mines .............. 150,000 $ 316,615 Newcrest Mining Ltd. ............. 500,000 2,139,878 *Saint Barbara Mines .............. 1,575,000 1,318,318 *Valdora Minerals ................. 2,800,000 550,254 ----------- TOTAL AUSTRALIA 4,325,065 ----------- CANADA (40.47%) Barrick Gold Corp. ............... 140,000 3,397,683 *Dayton Mining Corp. .............. 505,000 1,559,846 (DD)Franco Nevada Mining Ltd. ........ 8,000 400,074 Franco Nevada Mining Ltd. ........ 40,200 2,010,369 *Golden Knight Resources, Inc. .... 86,400 571,870 *Great Lakes Minerals, Inc. ....... 500,000 588,343 *Pegasus Gold, Inc. ............... 252,300 3,107,941 Placer Dome, Inc. ................ 190,000 4,523,810 *Prime Resources Group, Inc. ...... 494,700 3,410,783 *TVX Gold, Inc. ................... 1,500,000 10,893,547 ----------- TOTAL CANADA 30,464,266 ----------- SOUTH AFRICA (10.10%) (D)Ashanti Goldfields (ADR) ......... 125,000 3,125,000 Deelkraal Gold Mining Co. Ltd. (ADR) .......................... 138,300 131,385 Free State Consolidated Gold Mines Ltd. (ADR) ............ 120,000 1,425,000 Vaal Reef Exploration (ADR) ...... 477,000 2,921,625 ----------- TOTAL SOUTH AFRICA ........... 7,603,010 ----------- UNITED STATES (26.80%) *Atlas Corp. (b) ................. 455,000 830,375 *Canyon Resources Corp. .......... 875,000 1,804,688 *Greenstone Resources Ltd. ....... 1,293,100 1,737,603 Homestake Mining ................ 195,800 3,304,125 *Kinross Gold Corp. .............. 600,000 3,600,000 Newmont Mining Corp. ............ 70,000 2,931,250 *Santa Fe Pacific Gold Corp. ..... 473,000 5,971,625 ----------- TOTAL UNITED STATES .......... 20,179,666 ----------- (Right Column) Value ----- TOTAL METAL MINING SECURITIES ................... $62,572,007 ----------- TOTAL COMMON STOCKS (IDENTIFIED COST $68,453,952) ................. 62,572,007 ----------- BULLION (3.04%) Ounces ------ *Silver ............................ 400,000 2,288,800 ----------- TOTAL BULLION (IDENTIFIED COST $2,148,000) .................. 2,288,800 ----------- WARRANTS (1.56%) Warrants -------- (DD)*Triton Mining Corp. Warrants (expire 10/27/95) .......... 439,000 1,178,415 ----------- TOTAL WARRANTS (IDENTIFIED COST $890,006) ................... 1,178,415 ----------- Principal --------- SHORT-TERM SECURITIES (13.23%) GOVERNMENT OBLIGATION (12.22%) U.S. Treasury Bill 5.75%, 5/4/95 ...................... 9,200,000 9,195,754 COMMERCIAL PAPER (1.01%) American Express Credit Corp. 5.70%, 5/1/95 ............... 760,000 760,000 ----------- TOTAL SHORT-TERM SECURITIES (IDENTIFIED COST $9,955,754) ................. 9,955,754 ----------- TOTAL INVESTMENTS (IDENTIFIED COST $81,447,712) (a) (100.95%) ................... 75,994,976 LIABILITIES IN EXCESS OF CASH AND OTHER ASSETS (-.95%) ..................... (713,115) ----------- NET ASSETS (100%) ........... $75,281,861 =========== *Non-income producing. (D)Registered under SEC rule 144a, resale restricted as to qualified institutional buyers; represents 4.1% of net assets. (DD)The following securities are restricted: Security Acquisition Cost Date Acquired % of Net Assets -------- ---------------- ------------- --------------- Franco Nevada Mining Ltd. $ 93,586 November 1991 0.53 Triton Mining Corp. Warrants $890,007 October 1994 1.57 (a)The aggregate cost for federal income tax purposes is $81,572,091; the gross unrealized appreciation is $3,908,323 and the gross unrealized depreciation is $9,485,438; resulting in net unrealized depreciation of $5,577,115. (b) Security is a unit consisting of one share of common stock and half a warrant. See notes to financial statements. 3 BLANCHARD PRECIOUS METALS FUND, INC. (Left Column) STATEMENT OF ASSETS AND LIABILITIES April 30, 1995 Assets: Investments in securities, at value (Identified Cost $79,299,712) (note 1) ... $73,706,176 Investment in bullion, at value (Identified Cost $2,148,000) ............. 2,288,800 Cash ....................................... 73,396 Receivables for: Investments sold ......................... 1,916,605 Capital stock sold ....................... 295,703 Interest and Dividends ................... 10,151 Total assets ................ 78,290,831 Liabilities: Payables for: Investments purchased .................... 1,488,195 Capital stock repurchased ................ 1,397,636 Accrued expenses and other liabilities ... 123,139 Total liabilities ........... 3,008,970 Net assets .................. $75,281,861 Net assets are comprised of: Paid in capital (unlimited authorized shares of capital stock, $.001 par value, 10,570,288 shares outstanding) ............. $83,303,714 Accumulated distributions in excess of realized gain-net ..................................... (2,402,669) Accumulated investment loss-net .............. (166,448) Unrealized net depreciation of investments ... (5,452,736) Net assets ................................... $75,281,861 Net asset value per share .................... $7.12 (Right Column) STATEMENT OF OPERATIONS For the Year Ended April 30, 1995 Investment Income: Dividends (net of w/h taxes of $25,242) ..... $ 480,104 Interest .................................... 280,575 ----------- Total income ................. 760,679 ----------- Expenses: Investment management fee (note 2) .......... 756,766 Plan of distribution fee (note 3) ........... 567,575 Transfer agent fees ......................... 186,770 Directors' fees, retirement plan curtailment and other expenses (note 5) ............... 91,330 Accounting fees ............................. 78,900 Professional fees ........................... 72,297 Registration fees ........................... 52,274 Custodian fees .............................. 37,000 Shareholder reports and notices ............. 34,767 Other ....................................... 4,095 ----------- Total expenses ............... 1,881,774 ----------- Investment loss-net .......... (1,121,095) ----------- Realized and unrealized gain (loss)-net (note 1): Realized gain (loss) on: Investments in securities, net ........................ 401,623 Bullion transactions-net ......... (140,613) Foreign exchange transactions-net ............... (6,934) 254,076 ------- Change in unrealized appreciation or depreciation on investments-net ........... (3,793,965) ----------- Net realized and unrealized gain (loss) ..... (3,539,889) ----------- Net decrease in net assets resulting from operations ................................ $(4,660,984) =========== See notes to financial statements. 4 BLANCHARD PRECIOUS METALS FUND, INC. STATEMENT OF CHANGES IN NET ASSETS
For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment loss-net .............................................. $(1,121,095) $(726,850) Realized gain-net ................................................ 254,076 15,050,535 Change in unrealized appreciation (depreciation)-net ............ (3,793,965) (4,623,669) ----------- --------- Net increase (decrease) in net assets resulting from operations .. (4,660,984) 9,700,016 ----------- --------- Dividends and distributions to shareholders from: Realized gains-net ............................................... (254,076) - Distribution in excess of realized gains-net ..................... (9,876,340) - Tax return of capital ............................................ (894,701) - ----------- --------- (11,025,117) - ----------- --------- Transactions in capital stock-net increase (note 6) .................. 22,875,091 25,755,918 ----------- --------- Net increase in net assets ....................................... 7,188,990 35,455,934 Net assets: Beginning of year .................................................. 68,092,871 32,636,937 ----------- --------- End of year (including accumulated investment loss-net of $166,448 and $7,356, respectively.) ....................................... $75,281,861 $68,092,871 =========== ===========
See notes to financial statements. 5 BLANCHARD PRECIOUS METALS FUND, INC. NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard Precious Metals Fund, Inc. (the "Fund") is a corporation under the laws of the State of Maryland. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940 (the "Act"). The Fund had no operations before June 22, 1988 other than the sale of 12,500 shares of capital stock for $100,000 to eight parties who are also shareholders or affiliates of shareholders of Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Directors or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. Bullion investments are valued at the closing spot price based on dealer or exchange quotations. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Directors. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. There are certain risks involved in concentrating in specific industries such as mining that are in addition to the usual risks inherent in domestic instruments. These risks include those resulting from future adverse political and economic developments and possible imposition of foreign governmental laws or restrictions. B. Accounting for Investments-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date, except that certain dividends from foreign securities are recorded as soon as the Fund is informed after the ex-dividend date. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rates at the end of the period; and (2) purchases, sales, income and expenses are translated at the rates of exchange prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from changes in market prices of equity investments during the year. The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future foreign exchange rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. Risks may arise as a result of the potential inability of the counterparties to meet the terms of their contracts. At April 30, 1995, the Fund had no outstanding forward currency contracts. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, the level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. D. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. 6 BLANCHARD PRECIOUS METALS FUND, INC. NOTES TO FINANCIAL STATEMENTS (continued) E. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains or net investment income. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in capital. F. Organizational Expenses-The Manager paid organizational expenses of the Fund incurred prior to the public offering of its shares amounting to approximately $179,000. The Fund has reimbursed the Manager for such expenses. The Fund has deferred and amortized such expenses over five years from the date of commencement of the Fund's operations. G. Other-Certain expenses for the Blanchard Group of Funds are allocated among the Funds based upon their relative average net assets. NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Directors. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of 1% of the first $150 million of the Fund's average daily net assets, .875% of the Fund's average daily net assets in excess of $150 million but not exceeding $300 million and .75% of the Fund's average daily net assets in excess of $300 million. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses for which a waiver has been obtained, are subject to the expense limitation imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed the above limitation. Certain officers and/or Directors of the Fund are officers/directors of the Manager. The Manager has a sub-advisory agreement with Cavelti Capital Management, Ltd. (the "Portfolio Adviser"). The Manager has advised the Fund that the aggregate amount of fees paid to the Portfolio Adviser was $227,033 for the year ended April 30, 1995. NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor"), an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealer and shareholders servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .75% per annum of the Fund's average daily net assets. Payments under the Plan will be made for expenses actually incurred by the Distributor. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after May 1, 1988, but not yet 7 BLANCHARD PRECIOUS METALS FUND, INC. NOTES TO FINANCIAL STATEMENTS (continued) reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $425,390. If the plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Precious Metals Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments and bullion, aggregated $72,351,960 and $74,096,773, respectively. The Distributor has advised the Fund that it received $2,250 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that for the year ended April 30, 1995 it incurred costs, which were reimbursed by the Fund, amounting to $83,948 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Directors fees and expenses in the Statement of Operations for the year ended April 30, 1995 was $18,304. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $58,569 was recorded to reflect the previously unrecognized prior service costs of the independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $76,873 of accrued pension expense. NOTE 6 - Capital Stock:
For the Year Ended For the Year Ended April 30, 1995 April 30, 1994 ----------------------------- ------------------------------ Shares Amount Shares Amount ------ ------ ------ ------ Sold ......................................... 9,822,619 $81,070,800 12,811,047 $109,869,217 Reinvestment of Dividends .................... 1,474,694 10,092,477 - - ---------- ----------- ---------- ------------ 11,297,313 91,163,277 12,811,047 109,869,217 ---------- ----------- ---------- ------------ Repurchased .................................. (8,527,815) (68,288,186) (9,789,580) (84,113,299) ---------- ----------- ---------- ------------ Net increase ................................. 2,769,498 $22,875,091 3,021,467 $ 25,755,918 ========== =========== ========== ============
8 BLANCHARD PRECIOUS METALS FUND, INC. NOTES TO FINANCIAL STATEMENTS (continued) NOTE 7 - Federal Income Taxes: Capital losses incurred after October 31 ("post-October losses") within the taxable year are deemed to arise on the first business day of the Fund's next taxable year. The Fund incurred and will elect to defer net capital losses of approximately $2,368,000 during fiscal 1995. As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to post-October loss deferrals and non-deductible expenses. The Fund had permanent book/tax differences primarily attributable to a tax basis return of capital and net operating losses. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $1,073,701, accumulated realized gain-net was credited $119,054 and accumulated investment loss-net was credited $954,647. NOTE 8 - Financial Highlights: Selected ratios and per share data for a share of capital stock outstanding:
For the Year Ended April 30, -------------------------------------------------- 1995 1994 1993 1992 1991 ---- ---- ---- ---- ---- Per Share Operating Performance: Net asset value, beginning of year $ 8.73 $ 6.83 $ 5.04 $ 5.29 $ 6.30 ------ ------ ------ ------ ------ Income from investment operations: Net investment loss (.02) (.11)(D) (.08)(D) (.09)(D) (.08)(D) Net gains or losses on investments (both realized and unrealized) (.41) 2.01(D) 1.87(D) (.16)(D) (.93)(D) ------ ------ ------ ------ ------ Net income (loss) from investment operations (.43) 1.90 1.79 (.25) (1.01) ------ ------ ------ ------ ------ Less dividends and distributions: Distributions from realized gains-net (.03) - - - - Distributions in excess of realized gains-net (1.06) - - - - Tax return of capital (.09) - - - - ------ ------ ------ ------ ------ Change in net asset value (1.61) 1.90 1.79 (.25) (1.01) ------ ------ ------ ------ ------ Net asset value, end of year $ 7.12 $ 8.73 $ 6.83 $ 5.04 $ 5.29 ====== ====== ====== ====== ====== Total return (4.39%) 27.8% 35.5% (4.7%) (16%) Ratio/Supplemental Data: Net assets, end of year ($ Million) $75 $68 $33 $21 $25 Ratio of expenses to average net assets 2.49% 2.46% 3.24% 3.09% 3.05% Ratio of net investment loss to average net assets (1.48%) (1.21%) (1.46%) (1.57%) (1.28%) Portfolio turnover 116% 174% 66% 62% 57%
- ------------- (D) Calculated based on average shares outstanding. 9 BLANCHARD PRECIOUS METALS FUND, INC. REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Blanchard Precious Metals Fund, Inc. In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statement of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Precious Metals Fund, Inc. (the "Fund") at April 30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities and bullion at April 30, 1995 by correspondence with custodians and brokers, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 10 (Left Column) Portfolio Advisers Shufro, Rose and Ehrman U.S. Equity Securities Fiduciary Trust International, Inc. Foreign Equity Securities Cavelti Capital Management, Ltd. Precious Metals Securities and Bullion Investment Advisers, Inc. U.S. Fixed Income Fiduciary Trust International, Inc. Foreign Fixed Income Martin Currie Inc. Emerging Markets Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Global Growth Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Global Growth Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD AMERICAN EQUITY FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard American Equity Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History.............................................. 2 Investment Objective and Policies............................................ 2 Investment Restrictions...................................................... 6 Portfolio Transactions....................................................... 8 Computation of Net Asset Value............................................... 9 Performance Information...................................................... 10 Additional Purchase and Redemption Information............................... 12 Tax Matters.................................................................. 12 The Management of the FUND................................................... 17 Management Services.......................................................... 22 Portfolio Advisory Services.................................................. 23 Administrative Services...................................................... 23 Distribution ^ Plan.......................................................... 24 Description of the FUND...................................................... 24 Shareholder Reports.......................................................... 25 Financial Statements.........................................................A-1 Manager Virtus Capital Management, Inc. Portfolio Adviser Provident Investment Counsel, Inc. Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. The FUND's investment objective is to provide long-term growth of capital. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with, the sections in the FUND's Prospectus entitled "Investment Objective and Policies" and "Certain Investment Techniques and Policies." The investment objective of the Fund is to provide long-term growth of capital. There is no assurance that the Fund will achieve its objective. The Fund will invest in equity securities, consisting of common stocks and securities having the characteristics of common stocks, such as convertible preferred stocks, convertible debt securities and warrants. The Fund will invest at least 65% and under normal circumstances expects to invest at least 80% of its assets in such equity securities. In selecting investments for the Fund, Provident Investment Counsel, Inc., the Fund's portfolio adviser ("Provident"), will select equity securities of companies of various sizes which are currently experiencing a rate of earnings growth greater than the average of such rate for all companies included in Standard & Poor's 500-Stock Index. It is expected that approximately half of the equity securities in which the Fund will invest will be listed and traded on the New York Stock Exchange, and the remainder will be traded on the National Association of Securities Dealers' NASDAQ system or are otherwise traded over the counter. Provident supports its selection of individual securities through intensive research and uses qualitative and quantitative disciplines to determine when securities should be sold. Short-Term Investments. During those times when Provident does not believe that substantially all of the Fund's assets should be invested in equity securities, all or part of the Fund's assets may be invested temporarily in short-term investments. Under normal market conditions, it is expected that investments in such short-term instruments may range from zero (fully invested) to 30% of the Fund's assets. The short-term investments that may be purchased by the Fund consist of high quality debt obligations maturing in one year or less from the date of purchase, such as U.S. Government securities, certificates of deposit, bankers' acceptances and commercial paper. High quality means the obligations have been rated at least A-1 by S&P or Prime-1 by Moody's, or have an outstanding issue of debt securities rated at least A by S&P or Moody's, or are of comparable quality in the opinion of Provident. Short-term investments also include repurchase agreements with respect to the high quality debt obligations listed above. See "Repurchase Agreements" below. U.S. Government Securities. U.S. Government securities include direct obligations issued by the United States Treasury, such as Treasury bills, certificates of indebtedness, notes and bonds. U.S. Government agencies and instrumentalities that issue or guarantee securities include, but are not limited to, the Federal Home Loan Banks, the Federal National Mortgage Association and the Student Loan Marketing Association. Except for U.S. Treasury securities, obligations of U.S. Government agencies and instrumentalities may or may not be supported by the full faith and credit of the United States. Some, such as those of the Federal Home Loan Banks, are backed by the right of the issuer to borrow from the Treasury; others by discretionary authority of the U.S. Government to purchase the agencies' obligations; while still others, such as the Student Loan Marketing Association, are supported only by the credit of the instrumentality. In the case of securities not backed by the full faith and credit of the United States, the investor must look principally to the agency or instrumentality issuing or guaranteeing the obligation for ultimate repayment and -2- may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitment. Non-Diversification. The FUND is a "non-diversified" investment company portfolio, which means that the FUND is not limited in the proportion of its assets that may be invested in the securities of a single issuer. However, the FUND intends to conduct its operations so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"), which will relieve the FUND of any liability for Federal income tax to the extent its earnings are distributed to shareholders. See "Tax Matters." To so qualify, among other requirements, the FUND will limit its investments so that, at the close of each calendar quarter, (i) not more than 25% of the market value of the FUND's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value of its total assets will be invested in the securities of a single issuer and the FUND will not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the FUND's requirements to maintain diversification for tax purposes, the issuer of a loan participation will be the underlying borrower. In cases where the FUND does not have recourse directly against the borrower, both the borrower and each agent bank and co-lender interposed between the FUND and the borrower will be deemed issuers of the loan participation for tax diversification purposes. The FUND's investments in U.S. Government Securities are not subject to these limitations. Since the FUND, as a non-diversified investment company, may invest in a smaller number of individual issuers than a diversified investment company, an investment in the FUND may, under certain circumstances, present greater risk to an investor than an investment in a diversified company. Stock Index Futures Contracts The Fund may buy and sell stock index futures contracts. The Fund will enter into these transactions for bona fide hedging purposes, i.e., in order to hedge against changes in prices of the Fund's securities. A stock index futures contract is an agreement pursuant to which one party agrees to deliver to the other an amount of cash equal to a specific dollar amount times the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made. If Provident expected general stock market prices to rise, it might purchase a stock index futures contract as a hedge against an increase in prices of particular equity securities it wanted ultimately to buy. If in fact the stock index did rise, the price of the equity securities intended to be purchased might also increase, but that increase would be offset in part by the increase in the value of the Fund's futures contract resulting from the increase in the index. On the other hand, if Provident expected general stock market prices to decline, it might sell a futures contract on the index. If that index did in fact decline, the value of some or all of the equity securities held by the Fund might also be expected to decline, but that decrease would be offset in part by the increase in the value of the futures contract. Transactions are covered by owning or having the right to acquire corresponding securities or by maintenance of a cash segregated account pursuant to applicable provisions and staff interpretations of the 1940 Act. The FUND may not enter into futures transactions if the sum of the amount of initial margin deposits on its existing futures contracts would exceed 5% of the fair market value of the FUND'S total assets. The FUND will not use leverage when it enters into long futures contracts and for each such long position the FUND will deposit cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, having a value equal to the underlying commodity value of the contract as collateral with its custodian in a segregated account. The purpose of entering into a futures contract is to protect the FUND from fluctuations in the value of its portfolio securities or to hedge against an increase in prices of certain securities without necessarily buying or selling the securities. Of course, because the value of portfolio securities will far exceed the value of the futures contracts sold by the FUND, an increase in the value of the futures contracts could only mitigate but -3- not totally offset the decline in the value of the FUND's assets. No consideration is paid or received by the FUND upon entering into a futures contract. Upon entering into a futures contract, the FUND will be required to deposit in a segregated account with its custodian an amount of cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange on which the contract is traded and brokers may charge a higher amount). This amount is known as "initial margin" and 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 broker will have access to amounts in the margin account if the FUND fails to meet its contractual obligations. Subsequent payments, known as "variation margin," to and from the broker, will be made daily as the price of the currency or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract more or less valuable, a process known as "marking-to-market." At any time prior to the expiration of a futures contract, the FUND may elect to close the position by taking an opposite position, which will operate to terminate the FUND's existing position in the contract. There are several risks in connection with the use of futures contracts as a hedging device. Successful use of futures contracts is subject to the ability of FUND management to predict correctly movements in the price of the securities or currencies underlying the particular hedge. These predictions and, thus, the use of futures contracts involve skills and techniques that are different from those involved in the management of the portfolio securities being hedged. In addition, there can be no assurance that there will be a correlation between movements in the price of the underlying securities and movements in the price of the securities which are the subject of the hedge. A decision concerning whether, when and how to hedge involves the exercise of skill and judgment and even a well-conceived hedge may be unsuccessful to some degree because of unexpected market behavior or trends in interest rates. Positions in futures contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange). No secondary market for such contracts exists. Although the FUND intends to enter into futures contracts only if there is an active market for such contracts, there is no assurance that an active market will exist for the contracts at any particular time. Most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting the FUND to substantial losses. In such event, and in the event of adverse price movements, the FUND would be required to make daily cash payments of variation margin. In such circumstances, an increase in the value of the portion of the FUND's securities being hedged, if any, may partially or completely offset losses on the futures contract. However, as described above, there is no guarantee that the price of the securities being hedged will, in fact, correlate with the price movements in a futures contract and thus provide an offset to losses on the futures contract. If the FUND has hedged against the possibility of an event adversely affecting the value of securities held in its portfolio and that event does not occur, the FUND will lose part or all of the benefit of the increased value of securities which it has hedged because it will have offsetting losses in its futures positions. Losses incurred in hedging transactions and the costs of these transactions will affect the FUND's performance. In addition, in such situations, if the FUND had insufficient cash, it might have to sell securities to meet daily variation margin requirements at a time when it would be disadvantageous to do so. These sales of securities could, but will not necessarily, be at increased prices which reflect the change in interest rates or currency values, as the case may be. -4- Repurchase Agreements The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans as defined by the Investment Company Act of 1940, as amended (the "1940 Act"), collateralized by the underlying securities. The return on the collateral may be more or less than that from the repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day and the value of the collateral maintained will be at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, the Manager will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. Lending of Portfolio Securities In order to generate additional income, the FUND may lend its portfolio securities in an amount up to 33-1/3% of total FUND assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities. No lending may be made to any companies affiliated with VCM. The borrower at all times during the loan must maintain with the FUND cash or cash equivalent collateral or provide to the FUND an irrevocable letter of credit equal in value at all times to at least 100% of the value of the securities loaned. During the time portfolio securities are on loan, the borrower pays the FUND any dividends or interest paid on such securities, and the FUND may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. Loans are subject to termination at the option of the FUND or the borrower at any time. The FUND may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the income earned on the cash to the borrower or placing broker. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. This limitation may be subject to additional restrictions imposed by jurisdictions in which the Fund's shares are offered for sale. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, and (c) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions -5- within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 10% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering". Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The Commission has recently adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decisions, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers willing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. As a non-diversified management investment company, the FUND has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of -6- the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within any one industry other than the banking industry; or (d) more than 5% of net assets would be invested in warrants or rights. (Included within that amount, but not to exceed 2% of the value of the FUND's net assets, may be warrants which are not listed on the New York or American Stock Exchanges.) 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 20% of the market value of its total assets). This does not preclude the FUND from obtaining such short-term credit as may be necessary for the clearance of purchases and sales of its portfolio securities. The FUND will not purchase additional securities while the amount of any borrowings is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities except (i) through repurchase agreements, (ii) through loan participations, and (iii) through the lending of its portfolio securities as described in "Lending of Portfolio Securities" in the Prospectus and in this Statement. 5. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities, except as they may be acquired as part of a merger, consolidation or acquisition of assets. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 7. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales or maintain a short position (except for short sales against the box). 8. The FUND may not invest in companies for the purpose of exercising control or management. 9. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 10. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 11. The FUND may not purchase or sell real property (including limited partnership interests, but excluding readily marketable interests in real estate investment trusts or readily marketable securities of companies which invest in real estate). 12. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs or leases. -7- 13. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders, it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by Provident subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreement between VCM and Provident. In selecting such brokers or dealers, Provident will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to Provident for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to Provident. Such allocation shall be in such amounts as VCM shall determine and Provident shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to Provident in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of Provident's other clients may be useful to Provident in carrying out its obligations to the FUND. The receipt of such research may not reduce Provident's normal independent research activities. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. Provident is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and Provident or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from brokerage commissions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of -8- VCM. The Investment Advisory Contract does not provide for any reduction in the management fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between VCM and Provident does not provide for any reduction in the advisory fees as a result of profits resulting from brokerage commissions effected through Provident or an affiliated brokerage firm. For the period November 9, 1992 (commencement of operations) through April 30, 1993 and for the years ended April 30, 1995 and 1994, the FUND incurred brokerage commission expenses of $29,374, $19,368 and $59,728, respectively from the purchase and sale of portfolio securities. The Trustees had adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid the Distributor or to Provident or an affiliated broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time". The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. It may happen that the same security will be held by other clients of VCM or of Provident. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. For the fiscal years ended April 30, 1995 and 1994, the FUND's annual rate of portfolio turnover was 45% and 97%, respectively. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4: ^ 15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, normally 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior -9- to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 P.M. (New York Time) will be confirmed at the previous offering price computed as of the close of the regular trading session on the New York Stock Exchange (normally 4:00 P.M., New York Time), provided the order is received by the FUND's Transfer Agent prior to 4:15 P.M. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 P.M. will be confirmed at the next computed offering price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the one year period ended April 30, 1995 and for the life of fund (November 9, 1992 to April 30, 1995 was 4.83% and -.51%, respectively. -10- The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: YIELD 2[( a-b+1)6-1] ---------- cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. Under this formula, interest earned on debt obligations for purposes of "a" above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing -11- performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND; however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to Federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses, including foreign currency gains and loss) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock -12- or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). For purposes of these calculations, gross income includes tax-exempt income. However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued during the period of time the FUND held the debt obligation. Generally, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, regardless of whether a taxpayer's obligations (or rights) under such contract have terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the entire taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service has held in several private rulings (which may not be applicable to the FUND), that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test -13- as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. At April 30, 1995, the FUND had a net capital loss carryover of $891,524 which is available, to the extent provided in regulations, to 2003. In addition to satisfying the requirements described above, the fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of its taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. -14- FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for Federal income tax purposes, but they will qualify for the 70% dividends-received deduction for corporations only to the extent discussed below. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. Ordinary income dividends paid by the FUND with respect to a taxable year will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as "S" corporations, which are not eligible for the deduction and other than for purposes of special taxes such as the accumulated earnings tax and the personal holding company tax) to the extent of the amount of qualifying dividends received by the FUND from domestic corporations for the taxable year. A dividend received by the FUND will not be treated as a qualifying dividend (1) if it has been received with respect to any share of stock that the FUND has held for less than 46 days (91 days in the case of certain preferred stock), excluding for this purpose (under the rules of Code Section 246(c)(3) and (4)) (i) any day more than 45 days (or 90 days in the case of certain preferred stock) after the date on which the stock becomes ex-dividend and (ii) any period during which the FUND has an option to sell, is under a contractual obligation to sell, has made and not closed a short sale of, is the grantor of a deep-in-the-money or otherwise nonqualified option to buy, or has otherwise diminished its risk of loss by holding other positions with respect to, such (or substantially identical) stock; (2) to the extent that the FUND is under an obligation (pursuant to a short sale or otherwise) to make related payments with respect to positions in substantially similar or related property; or (3) to the extent the stock on which the dividend is paid is treated as debt-financed under the rules of Code Section 246A. Moreover, the dividends-received deduction for a corporate shareholder may be disallowed or reduced (i) if the corporate shareholder fails to satisfy the foregoing requirements with respect to its shares of the FUND or (ii) by application of Code Section 246(b) which in general limits the dividends-received deduction to 70% of the shareholder's taxable income (determined without regard to the dividends-received deduction and certain other items). AMT is imposed in addition to, but only to the extent it exceeds, the regular tax and is computed at the maximum marginal rate of 28% for noncorporate taxpayers and 20% for corporate taxpayers on the excess of the taxpayer's alternative minimum taxable income ("AMTI") over an exemption amount. In addition, under the Superfund Amendments and Reauthorization Act of 1986, a tax is imposed for taxable years beginning after 1986 and before 1996 at the rate of 0.12% on the excess of a corporate taxpayer's AMTI (determined without regard to the deduction for this tax and the AMT net operating loss deduction) over $2 million. The corporate dividends-received deduction is not itself an item of tax preference that must be added back to taxable income or is otherwise disallowed in determining a corporation's AMTI. However, corporate shareholders will generally be required to take the full amount of any dividend received from the FUND into account (without a dividends-received deduction) in determining its adjusted current earnings, which are used in computing an additional corporate preference item (i.e., 75% of the excess of a corporate taxpayer's adjusted current earnings -15- over its AMTI (determined without regard to this item and the AMT net operating loss deduction)) includable in AMTI. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid by January 31 of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (discussed above in connection with the dividends-received deduction for corporations) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. -16- Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Such a foreign shareholder would generally be exempt from U.S. Federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. Federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. Federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. Federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. Federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, -17- Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.;
-18- Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Treasurer and Trustee of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Treasurer and Trustee of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services
-19- Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds.
-20- Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. -21- Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. Officers and Trustees Compensation
- -------------------------------------------------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex
-22- Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
MANAGEMENT SERVICES Manager to the Trust The Trust's Manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the period from November 9, 1992 (commencement of operations) to April 30, 1993 and the fiscal years ended April 30, 1995 and 1994, the FUND's investment management fees paid to the prior manager were $75,933, $128,735 and $252,733, respectively, less voluntary expense reimbursements of $42,014, $92,524 and $2,469, respectively. PORTFOLIO ADVISORY SERVICES Pursuant to a sub-advisory agreement (the "Sub-Advisory Agreement") between VCM and the portfolio manager, Provident Investment Counsel, Inc. ("Provident"), VCM has delegated to Provident the authority and responsibility to make and execute decisions for the Fund within the framework of the Fund's investment policies, subject to review by VCM and the Board of Trustees of the Fund. Under the terms of the Sub-Advisory Agreement, Provident has discretion to purchase and sell securities, except as limited by the Fund's investment objective, policies and restrictions. The Sub-Advisory Agreement provides for the payment to Provident, by VCM, of monthly compensation based on the Fund's average daily net assets for providing investment advice to the Fund and managing the investment of the assets of the Fund. These fees are determined by applying the following annual -23- rates to the Fund's average daily net assets: .50% of the first $150 million; .45% of the next $100 million; .40% of the next $150 million; and .35% of average daily net assets in excess of $400 million. The prior manager has advised the FUND that the fees paid to Provident were $34,537 for the period ended April 30, 1993 $122,075 for the fiscal year ended April 30, 1994 and $45,521 for the year ended April 30, 1995. The Sub-Advisory Agreement, dated July 11, 1995 was approved by the then Trustees on March 24, 1995. The Sub-Advisory Agreement provides that it may be terminated without penalty by either the Fund or Provident at any time by the giving of 60 days' written notice to the other and terminates automatically in the event of "assignment", as defined in the Investment Company Act. The Sub-Advisory Agreement provides that, unless sooner terminated, it shall continue in effect for an initial two year period, and from year to year thereafter only so long as such continuance is specifically approved at least annually by either the Board of Trustees of the Fund or by a vote of the majority of the outstanding voting securities of the Fund, provided, that in either event, such continuance is also approved by the vote of the majority of the Trustees who are not parties to the Sub-Advisory Agreement or "interested persons" of such parties cast in person at a meeting called for the purpose of voting on such approval. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the Fund accrued payments under the Plan amounting to $58,516. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares whose needs are served by the Fund's objectives, -24- and properly servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. ^ FINANCIAL STATEMENTS Audited financial statements of the FUND for the fiscal year ended April 30, 1995 are attached hereto. -25- Dear Shareholders, Enclosed you will find the Annual Report for your Blanchard American Equity Fund for the fiscal year ending April 30, 1995. As you know, the investment objective of the Fund is to seek long-term price appreciation through a portfolio of high-quality securities of well-established "growth" companies. These companies have a history of consistent and sustainable revenue and earnings growth, regardless of the economic environment. Other superior financial characteristics of the stocks in the Fund's portfolio include excellent pre-tax margins, high returns on equity, and high-dividend growth rates. The Year In Review The equity markets have advanced during the first quarter of calendar 1995, pushing both the Dow Jones and the S&P 500 indices to record levels. As the quarter progressed, investors gained confidence that the economy was beginning to slow in reaction to the Federal Reserve's seven interest rate increases over the last year. Evidence of slowing economic growth convinced investors that long-term rates had probably peaked during this cycle. As a result, the market shrugged off weakness in the dollar and the economic crisis in Mexico and concentrated on the favorable implications of a domestic "soft landing". The Fund has advanced in a similar fashion, although it has trailed the S&P 500 index. The technology sector showed continued strength, as did telecommunications, financial and gaming-related issues. This was partially offset by the underperformance of issues in the retail and HMO industries. The dramatic move that the market made during the first quarter of 1995 stands in stark contrast to the preceding nine months, during which the market was constantly The following information was reprint as a line graph. The Value of a $10,000 Investment in the Blanchard American Equity Fund inception 11/2/92 through 4/30/95 as compared to the Standard & Poor's 500 for the same period ----------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard American Equity Fund* ----------------------------------------- 1 year 4.83% since inception -0.51% ----------------------------------------- FYE 4/30/93 FYE 4/30/94 FYE 4/30/95 AEF -9.00% 3.52% 4.83% S&P 500 6.60% 5.33% 17.40% $9,925 $ 9,032 9,350 $ 9,801 $10,000 $10,660 $11,228 $13,182 Reflects deduction of $75 acct opening fee Blanchard Standard American Equity & Poor's Fund^ 500(D) *The average annual returns quoted above reflect reinvestment of distributions but do not reflect the deduction of the account opening fee. If fee was reflected, the returns would be lower. The total return includes changes in principal value. The average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: S&P 500 is an unmanaged composite index of U.S. stock market performance. ^Reflects deduction of the one-time account opening fee of $75. This chart is for comparative purposes only and is not intended to reflect on future performance of the index or the BAEF. (over, please) battling to overcome the interest rate increases by the Federal Reserve. These nine months were characterized by extreme volatility in the prices of individual stocks and overall returns which were disappointing for both the Fund and the market. Investment Outlook At Provident we continue to focus on company fundamentals. Relative to the market, the companies in your portfolio _ such as Microsoft and Motorola, two of the Fund's top ten holdings as of this writing, 5/22/95 _ generate superior revenue growth, earnings growth and returns on equity. Naturally, past performance of these companies or of the Fund itself is no guarantee of future results. As with any stock mutual fund, principal value and investment return will vary with market conditions so that shares, when redeemed, may be worth more or less than their original purchase price. However, with a relative valuation in the lower part of its historical range, we believe your portfolio is well positioned for future performance. In addition, initial signs that the economy is beginning to slow should make earnings gains by cyclical companies more difficult. Evidence of a peak in cyclical earnings is supported by the fact that the ratio of earnings estimate increases versus decreases for economically sensitive stocks appears to have peaked last quarter. This scenario favors the growth stocks in which your portfolio invests _ companies whose earnings potential has traditionally been unaffected by cyclical changes in the economy. While there can be no assurances of success, we enter the current year with a great deal of optimism about the prospects for your Blanchard American Equity Fund, and we look forward to reporting strong results to you at this time next year. Sincerely, JM:ml Jeffrey Miller Managing Director Provident Investment Counsel Portfolio Managers of the Blanchard American Equity Fund Distributed by Sheffield Investments, Inc. (1551) 04ARSL0695 BLANCHARD AMERICAN EQUITY FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Shares Value ------ ----- EQUITY SECURITIES (97.15%) Auto Parts (1.73%) *Autozone, Inc. ..................... 7,200 $ 166,500 --------- Building Products (3.80%) Home Depot, Inc. ................... 8,767 366,022 --------- Broadcast, Radio & TV (3.16%) Capital Cities/ABC, Inc. ........... 3,600 304,200 --------- Computer Software & Service (16.65%) *Analog Devices, Inc. ............... 4,800 129,000 Automatic Data Processing, Inc. .... 2,800 179,900 *Cabletron Systems, Inc. ............ 2,350 111,625 Computer Associates International, Inc. .............. 2,200 141,625 *Computer Sciences Corp. ............ 2,200 108,625 *Microsoft, Inc. 6,000 490,500 *Oracle System Corp. ................ 12,600 384,300 Paychex, Inc. ...................... 1,200 57,150 --------- 1,602,725 --------- Electronics & Electrical (15.70%) *Applied Material, Inc. ............. 3,000 184,875 Hewlett Packard .................... 2,800 185,150 Intel Corp. ........................ 3,500 358,312 Molex Inc.-Cl. A ................... 750 27,000 Motorola, Inc. ..................... 6,300 358,313 Nokia Corp. (ADR) .................. 6,800 278,800 Sensormatics Electronics Corp. ..... 4,000 119,000 --------- 1,511,450 --------- Employment Services (.94%) Manpower Inc. ...................... 2,700 90,112 --------- Entertainment & Leisure (1.32%) *British Sky Broadcasting (ADR) ..... 2,400 57,600 *Hospitality Franchise System, Inc. . 2,300 69,863 --------- 127,463 --------- Environmental Control (.82%) Browning-Ferris Industries, Inc. ... 2,400 79,200 --------- Financial Services (13.51%) Federal Home Loan Mortgage Corp. ............................ 1,300 84,825 Federal National Mortgage Association ...................... 2,500 220,625 First Financial Management Corp. ... 1,700 124,312 First USA, Inc. .................... 3,400 144,500 First Data Corporation ............. 5,130 288,563 Finova Group Corp. ................. 3,400 114,750 MBNA Corp. ......................... 10,700 323,675 --------- 1,301,250 --------- Funeral Services (1.32%) Loewen Group, Inc. ................. 4,500 126,914 --------- Gaming (1.14%) *Circus Circus Enterprises, Inc. .... 3,300 109,312 --------- (Right Column) Shares Value ------ ----- Health Maintenance (6.92%) *Humana, Inc. ....................... 7,300 $ 142,350 U.S. Healthcare, Inc. .............. 6,975 186,581 United Healthcare Corp. ............ 9,300 337,125 --------- 666,056 --------- Insurance (3.15%) American International Group Inc. .. 800 85,400 MGIC Investment Corp. .............. 4,000 169,500 PMI Group .......................... 1,300 48,425 --------- 303,325 --------- Medical Services (3.32%) Cardinal Health, Inc. .............. 1,600 73,800 Medtronic, Inc. .................... 2,500 185,937 Sun Healthcare Group, Inc. ......... 2,500 60,313 --------- 320,050 --------- Natural Gas Products & Pipe (3.64%) Enron Corp. ........................ 10,300 350,200 --------- Office & Business Equipment (3.38%) Alco Standard Corporaion ........... 1,200 85,050 *Office Depot, Inc. ................. 7,550 171,763 Pittson Services Group ............. 2,900 68,875 --------- 325,688 --------- Pharmaceuticals (.79%) *Scherer R P Corp. .................. 1,600 76,400 --------- Real Estate (1.53%) Equity Residential Prop. Trust ..... 5,500 147,125 --------- Restaurants (1.27%) McDonalds Corp. .................... 3,500 122,500 --------- Retail (5.77%) Lowe's Cos. ........................ 3,100 89,513 Talbots Inc. ....................... 1,600 48,600 Tyco International ................. 2,300 120,750 Wal-Mart Stores, Inc. .............. 12,500 296,875 --------- 555,738 --------- Telecommunications (7.29%) *ALC Communications Corp. ........... 2,600 99,125 *Andrew Corp. ....................... 1,900 94,050 Ericsson L M Tel Co. Cl. B (ADR) ... 5,500 368,844 *General Instrument Corp. ........... 4,100 139,912 --------- 701,931 --------- TOTAL EQUITY SECURITIES (IDENTIFIED COST $7,973,450) ........ 9,354,161 --------- TOTAL INVESTMENTS (IDENTIFIED COST $7,973,450)(a)(97.15%) ............ 9,354,161 --------- CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (2.85%) ........................... 274,182 --------- NET ASSETS (100%) ................... $9,628,343 ========== (a)The aggregate cost for federal income tax purposes is $8,041,793; the aggregate gross unrealized appreciation is $1,627,094; and the gross depreciation is $314,726; resulting in net unrealized appreciation of $1,312,368. *Non-income producing. See notes to financial statements. 3 BLANCHARD AMERICAN EQUITY FUND Statement of Assets and Liabilities April 30, 1995 Assets: Investments in securities, at value (Identified Cost $7,973,450) (note 1) ......................... $9,354,161 Cash ............................................................ 28,264 Receivables for: Investments sold .............................................. 296,726 Shares of beneficial interest sold ............................ 30,345 Dividends ..................................................... 3,074 Reimbursement from Manager .................................... 6,000 Deferred organizational costs (note 1) .......................... 66,484 ---------- Total assets ............................................. 9,785,054 ---------- Liabilities: Payables for: Investments purchased ......................................... 47,767 Shares of beneficial interest repurchased ..................... 74,217 Accrued expenses and other liabilities .......................... 34,727 ---------- Total liabilities ........................................ 156,711 ---------- Net assets ............................................... $9,628,343 ========== Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 1,000,269 shares outstanding) ................. $9,219,364 Accumulated realized loss ....................................... (959,867) Accumulated net investment loss ................................. (11,865) Unrealized net appreciation on investments ...................... 1,380,711 ---------- Net assets ............................................... $9,628,343 ========== Net asset value per share ................................ $9.63 ===== See notes to financial statements. 4 BLANCHARD AMERICAN EQUITY FUND Statement of Operations For the Year Ended April 30, 1995 Investment income: Dividends $107,980 Interest 30,332 -------- Total income 138,312 -------- Expenses: Investment management fee (note 2) ................. $ 128,735 Transfer agent fees (note 5) ....................... 60,949 Plan of distribution fee (note 3) .................. 58,516 Accounting fees (note 5) ........................... 53,300 Professional fees .................................. 40,465 Organizational expenses ............................ 26,588 Custodian fees ..................................... 24,508 Shareholder reports and notices .................... 19,700 Registration fees .................................. 19,400 Trustees' fees, retirement plan curtailment and other expenses (note 5) .......................... 16,782 Other .............................................. 747 --------- Total expenses ........................... 449,690 Less: Expenses waived by Manager (note 2) .......... (92,524) --------- Net expenses ....................................... 357,166 -------- Investment loss-net ................................ (218,854) -------- Realized and unrealized gain (loss)-net (note 1): Realized loss on investments in securities-net ....... (304,036) Change in unrealized appreciation on investments ..... 1,056,341 ---------- Net realized and unrealized gain .............................. 752,305 -------- Net increase in net assets resulting from operations ........... $533,451 ======== See notes to financial statements. 5 BLANCHARD AMERICAN EQUITY FUND Statement of Changes in Net Assets
For the Year For the Year Ended Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment loss-net .............................................. $ (218,854) $ (467,930) Realized gain (loss)-net ......................................... (304,036) 601,197 Change in unrealized appreciation or depreciation-net ............ 1,056,341 1,663,800 ----------- ----------- Net increase in net assets resulting from operations ............. 533,451 1,797,067 ----------- ----------- Dividends and distributions to shareholders from: Tax return of capital ............................................ (259,191) - Transactions in shares of beneficial interest- net decrease (note 6) ............................................ (4,616,259) (18,975,186) ----------- ----------- Net decrease in net assets ..................................... (4,341,999) (17,178,119) Net assets: Beginning of year .................................................. 13,970,342 31,148,461 ----------- ----------- End of year (including accumulated net investment loss of $11,865 and $0, respectively) .................................... $ 9,628,343 $13,970,342 =========== ===========
See notes to financial statements. 6 BLANCHARD AMERICAN EQUITY FUND Notes To Financial Statements April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard American Equity Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940 ("the Act"). The Fund had no operations before November 9, 1992 other than the sale of 10,000 shares of beneficial interest for $100,000 to Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on a domestic exchange are valued at the 4 PM EST price on that exchange, and if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less, or by amortizing their value on the 61st day prior to maturity if their term to maturity at the date of purchase exceeded 60 days. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. B. Accounting for Investments-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Interest income is accrued daily. Dividend income and other distributions are recorded on the ex-dividend date. C. Federal Income Tax Status-It is Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. D. Dividends and Distribution to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains is determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income or net realized gains for financial reporting purposes but not for tax purposes are reported as dividends or distributions in excess of net investment income or net realized gains for tax purposes. To the extent they exceed net investment income or net realized gains for tax purposes they are reported as distributions of paid-in capital. E. Organizational Expenses-The Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to approximately $132,941. The Fund has reimbursed the Manager for such expenses and has deferred and is amortizing such expenses over five years from the date of commencement of the Fund's operations. 7 BLANCHARD AMERICAN EQUITY FUND Notes To Financial Statements (continued) April 30, 1995 F. Other-Certain expenses for the Blanchard Group of Funds are allocated among the funds based upon their relative average net assets. NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser as noted below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of 1.1% of the Fund's average daily net assets. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses, are subject to the expense limitation imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses exceeded the above limitation by $92,524 which was borne by the Manager through a fee waiver. Certain officers and/or Trustees of the Fund are officers/directors of the Manager. The Manager has a sub-advisory agreement with Provident Investment Counsel, Inc. (the "Portfolio Adviser"). All fees for such services are paid by the Manager. The Manager has advised the Fund that the fees paid to the Portfolio Adviser were $45,521 for the year ended April 30, 1995. NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor") an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .50% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after November 9, 1992, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $419,809. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation 8 BLANCHARD AMERICAN EQUITY FUND Notes To Financial Statements (continued) April 30, 1995 and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard American Equity Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2)a new distribution agreement with Federated Securities Corp., and (3)certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $4,819,865 and $8,716,371, respectively. The Distributor has advised the Fund that it received $188 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that, for the same period, it incurred costs, which were reimbursed by the Fund, amounting to $13,143 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees' fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $2,615. As indicated in Note4, the Manager has entered into an agreement which provides for the acquistion of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $9,250 was recorded to reflect the previously unrecognized prior service costs of the independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $11,865 of accrued pension expense. NOTE 6 - Shares of Beneficial Interest: For the Year Ended For the Year Ended April 30, 1995 April 30, 1994 ------------------------ --------------------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold ................. 417,825 $3,983,359 487,125 $ 4,708,461 Reinvestment of dividends and distributions ...... 27,994 253,349 - - -------- ----------- ---------- ------------ 445,819 4,236,708 487,125 4,708,461 Repurchased .......... (928,616) (8,852,967) (2,428,717) (23,683,647) -------- ----------- ---------- ------------ Net decrease ......... (482,797) $(4,616,259) (1,941,592) $(18,975,186) ======== =========== ========== ============ 9 BLANCHARD AMERICAN EQUITY FUND Notes To Financial Statements (continued) April 30, 1995 NOTE 7 - Federal Income Taxes: As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to wash sale loss deferrals. The Fund had permanent book/tax differences primarily attributable to net operating losses. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $466,180, accumulated realized loss-net was credited $33,889 and accumulated distributions in excess of investment income-net was credited $432,291. At April 30, 1995 the Fund had a net capital loss carryover of $891,524 of which $584,268 and $307,256 are available through April 30, 2002 and April 30, 2003, respectively, to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders. NOTE 8 - Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the Period November 9, 1992 For the Year Ended (commencement April 30, of operations) to ---------------------- April 30, 1995 1994 1993 ---- ---- ---- Per Share Operating Performance: Net asset value, beginning of period ................... $9.42 $9.10 $10.00 Income from investment operations: Net investment loss .................................. (.01)(DD) (.20)(DD) (.03)(DD) Net gains or losses on securities (both realized and unrealized) ........................................ .45 .52 (.87) Net income (loss) from investment operations ....... .44 .32 (.90) Less dividends and distributions from: Tax return of capital ................................ (.23) .00 .00 Change in net asset value ............................ .21 .32 (.90) Net asset value, end of period ......................... $9.63 $9.42 $ 9.10 Total return .......................................... 4.83% 3.52% (9.00%)(3) Ratios/Supplemental Data: Net assets end of period ($ Million) ................. $10 $14 $31 Ratio of expenses to average net assets .............. 3.05%(1) 3.00%(1) 3.13%(1)(2) Ratio of net investment loss to average net assets ... (1.87%)(1) (2.04%)(1) (1.66%)(1)(2) Portfolio turnover ..................................... 45% 97% 49%
(1) The ratios of expenses to average net assets and net investment loss to average net assets would have been 3.79% and (2.61%), respectively, for the year ended April 30, 1995, and 3.01% and (2.05%), respectively, for the year ended April 30, 1994, and 3.73% and (2.26%), respectively, for the period ended April 30, 1993, if a portion of the Fund's expenses had not been voluntarily reimbursed by the Manager. (2) Annualized. (3) Not annualized. 10 BLANCHARD AMERICAN EQUITY FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard American Equity Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard American Equity Fund (the "Fund") at April30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the two years in the period then ended and for the period November 9, 1992 (commencement of operations) through April 30, 1993, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 11 (Left Column) Portfolio Adviser Provident Investment Counsel, Inc. Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard American Equity Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard American Equity Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD FLEXIBLE INCOME FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Flexible Income Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History ............................................ 2 Investment Objective and Policies .......................................... 2 Investment Restrictions ................................................... 16 Portfolio Transactions ..................................................... 18 Computation of Net Asset Value ............................................. 19 Performance Information .................................................... 20 Additional Purchase and Redemption Information ............................. 21 Tax Matters ................................................................ 22 The Management of the FUND ................................................. 27 Management Services ........................................................ 31 The Sub-Advisory Agreement ................................................. 32 Administrative Services .................................................... 33 Purchasing Shares .......................................................... 26 Distribution Plan ......................................................... 34 Description of the FUND .................................................... 35 Shareholder Reports ........................................................ 35 Financial Statements ....................................................... 35 Manager Virtus Capital Management, Inc. Sub-Adviser OFFITBANK Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. The FUND's investment objective is to provide high current income while seeking opportunities for capital appreciation. There is no assurance that the FUND will achieve its investment objective. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with, the sections in the FUND's Prospectus entitled "Investment Objective and Policies" and "Certain Investment Strategies and Policies." The FUND intends to invest in the following fixed income securities markets: U.S. Government Securities. This consists of debt obligations of the U.S. Government and its agencies and instrumentalities and related options, futures and repurchase agreements. Investment Grade Fixed Income Securities. This consists of investment grade fixed income securities, including mortgage related and asset backed securities. High Yield Securities. This consists of higher yielding (and, therefore, higher risk), lower rated U.S. corporate fixed income securities. International Fixed Income Securities. This consists of obligations of foreign governments, their agencies and instrumentalities and other fixed income securities denominated in foreign currencies or composite currencies. OFFITBANK, the FUND's portfolio adviser, believes that the ability to invest the FUND's assets among these markets, as opposed to investing in any one, may enable the FUND to enhance current income and increase opportunities for capital appreciation while taking risk to principal into consideration. The Fund may invest up to 35% of its assets in lower quality fixed income securities. There is no limit on the percentage of FUND assets invested in any of the fixed income markets except for High Yield Securities which is limited to 35%, and further limited to the extent of any lower quality fixed income securities held in the International Fixed Income Securities portfolio. See "Risk Factors - Lower Rated Fixed Income Securities" in the FUND's Prospectus. At least 65% of the FUND's total assets generally will be invested in income-producing securities; however, the FUND expects that substantially all of its total assets will be invested in income-producing securities, together with certain futures, options and foreign currency contracts and other investments described below. The investment objective of providing high current income while seeking opportunities for capital appreciation is a fundamental policy and may not be changed without the authorization of the holders of a majority of the outstanding shares of the FUND, as defined in the Investment Company Act of 1940, as amended (the "1940 Act"). The other investment policies may be changed with the approval of the FUND's Board of Trustees, except as set forth under "Investment Restrictions" in this Statement of Additional Information. U.S. Government Securities FUND assets invested in this market will be invested exclusively in U.S. Government Securities and in options, futures contracts and repurchase transactions with respect to such securities. As used in this Prospectus, the term "U.S. Government Securities" refers to debt securities denominated in U.S. dollars issued or guaranteed by the U.S. government, by various of its agencies, or by various instrumentalities established or sponsored by the U.S. government. Certain of these obligations including U.S. Treasury bills, notes and bonds, -2- mortgage participation certificates guaranteed by the Government National Mortgage Association ("GNMA"), and Federal Housing Administration debentures, are supported by the full faith and credit of the United States. Other U.S. Government Securities issued or guaranteed by federal agencies or government sponsored enterprises are not supported by the full faith and credit of the United States. These securities include obligations supported by the right of the issuer to borrow from the U.S. Treasury, such as obligations of Federal Home Loan Banks, and obligations supported only by the credit of the instrumentality, such as Federal National Mortgage Association Bonds. When purchasing securities in the U.S. Government market, OFFITBANK may take full advantage of the entire range of maturities of U.S. Government Securities and may adjust the average maturity of the investments held in the portfolio from time to time, depending on its assessment of relative yields of securities of different maturities and its expectations of future changes in interest rates. To the extent that the FUND invests in the mortgage market, OFFITBANK usually will evaluate, among other things, relevant economic, environmental and security-specific variables such as housing starts, coupon and age trends. To determine relative value among markets OFFITBANK may use tools such as yield/duration curves, break-even prepayment rate analysis and holding-period-return scenario testing. The FUND may seek to increase its current income by writing covered call or put options with respect to some or all of the U.S. Government Securities held in its portfolio. In addition, the FUND may at times, through the writing and purchase of options on U.S. Government Securities, and the purchase and sale of futures contracts and related options with respect to U.S. Government Securities, seek to reduce fluctuations in net asset value by hedging against a decline in the value of U.S. Government Securities owned by the FUND or an increase in the price of such Securities which the FUND plans to purchase, although it is not the general practice to do so. Significant option writing opportunities generally exist only with respect to longer term U.S. Government Securities. Options on U.S. Government Securities and futures and related options are not considered U.S. Government Securities; accordingly, they have a different set of risks and features. These practices and related risks are described in "Certain Investment Strategies and Policies" in the FUND's Prospectus and in "Investment Objective and Policies" in this Statement of Additional Information. Description of Certain U.S. Government Mortgage-Related Securities GNMA Certificates Government National Mortgage Association. The Government National Mortgage Association is a wholly-owned corporate instrumentality of the United States within the U.S. Department of Housing and Urban Development. GNMA's principal programs involve its guarantees of privately issued securities backed by pools of mortgages. Nature of GNMA Certificates. GNMA Certificates are mortgage-backed securities. The Certificates evidence part ownership of a pool of mortgage loans. The Certificates which the FUND purchases are of the modified pass-through type. Modified pass-through Certificates entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or not the mortgagor actually makes the payment. GNMA Certificates are backed by mortgages and, unlike most bonds, their principal amount is paid back by the borrower over the length of the loan rather than in a lump sum at maturity. Principal payments received by the FUND will be reinvested in additional GNMA Certificates or in other permissible investments. GNMA Guarantee. The National Housing Act authorizes GNMA to guarantee the timely payment of principal of and interest on securities backed by a pool of mortgages insured by the Federal Housing Administration ("FHA") or the Farmers Home Administration or guaranteed by the Veterans Administration ("VA"). The GNMA guarantee is backed by the full faith and credit of the United States. GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. -3- Life of GNMA Certificates. The average life of a GNMA Certificate is likely to be substantially less than the original maturity of the mortgage pools underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures will result in the return of a portion of principal invested before the maturity of the mortgages in the pool. As prepayment rates of individual mortgage pools will vary widely, it is not possible to predict accurately the average life of a particular issue of GNMA Certificates. However, statistics published by the FHA are normally used as an indicator of the expected average life of GNMA Certificates. These statistics indicate that the average life of single-family dwelling mortgages with 25-30 year maturities (the type of mortgages backing the vast majority of GNMA Certificates) is approximately twelve years. For this reason, it is customary for pricing purposes to consider GNMA Certificates as 30-year mortgage-backed securities which prepay fully in the twelfth year. Yield Characteristics of GNMA Certificates. The coupon rate of interest of GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or FHA-insured mortgages underlying the Certificates, but only by the amount of the fees paid to GNMA and the GNMA Certificate issuer. For the most common type of mortgage pool, containing single-family dwelling mortgages, GNMA receives an annual fee of 0.06 of one percent of the outstanding principal for providing its guarantee, and the GNMA Certificate issuer is paid an annual servicing fee of 0.44 of one percent for assembling the mortgage pool and for passing through monthly payments of interest and principal to Certificate holders. The coupon rate by itself, however, does not indicate the yield which will be earned on the Certificates for the following reasons: 1. Certificates are usually issued at a premium or discount, rather than at par. 2. After issuance, Certificates usually trade in the secondary market at a premium or discount. 3. Interest is paid monthly rather than semi-annually as is the case for traditional bonds. Monthly compounding has the effect of raising the effective yield earned on GNMA Certificates. 4. The actual yield of each GNMA Certificate is influenced by the prepayment experience of the mortgage pool underlying the Certificate. If mortgagors prepay their mortgages, the principal returned to Certificate holders may be reinvested at higher or lower rates. In quoting yields for GNMA Certificates, the customary practice is to assume that the Certificates will have a twelve-year life. Compared on this basis, GNMA Certificates have historically yielded roughly 1/4 of one percent more than high grade corporate bonds and 1/2 of one percent more than U.S. Government and U.S. Government agency bonds. As the life of individual pools may vary widely, however, the actual yield earned on any issue of GNMA Certificates may differ significantly from the yield estimated on the assumption of a twelve-year life. Market for GNMA Certificates. Since the inception of the GNMA mortgage-backed securities program in 1970, the amount of GNMA Certificates outstanding has grown rapidly. The size of the market and the active participation in the secondary market by securities dealers and many types of investors make GNMA Certificates highly liquid instruments. Quotes for GNMA Certificates are readily available from securities dealers and depend on, among other things, the level of market rates, the Certificate's coupon rate and the prepayment experience of the pool of mortgages backing each Certificate. -4- FNMA Securities The Federal National Mortgage Association ("FNMA") was established in 1938 to create a secondary market in mortgages insured by the FHA. FNMA issues guaranteed mortgage pass-through certificates ("FNMA Certificates"). FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate represents a pro rata share of all principal and interest payments made and owed on the underlying pool. FNMA guarantees timely payment of interest and principal on FNMA Certificates. The FNMA guarantee is not backed by the full faith and credit of the United States. FHLMC Securities The Federal Home Loan Mortgage Corporation ("FHLMC") was created in 1970 to promote development of a nationwide secondary market in conventional residential mortgages. The FHLMC issues two types of mortgage pass-through securities ("FHLMC Certificates"): mortgage participation certificates ("PCs") and guaranteed mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in that each PC represents a pro rata share of all interest and principal payments made and owned on the underlying pool. The FHLMC guarantees timely monthly payment of interest on Pcs and the ultimate payment of principal. GMCs also represent a pro rata interest in a pool of mortgages. However, these instruments pay interest semiannually and return principal once a year in guaranteed minimum payments. The expected average life of these securities is approximately ten years. The FHLMC guarantee is not backed by the full faith and credit of the United States. Special Considerations U.S. Government Securities are considered among the most creditworthy of fixed income investments. Because of this added safety, the yields available from U.S. Government Securities are generally lower than the yields available from corporate debt securities. The values of U.S. Government Securities (like those of fixed income securities generally) will change as interest rates fluctuate. During periods of falling U.S. interest rates, the values of outstanding long term U.S. Government Securities generally rise. Conversely, during periods of rising interest rates, the values of such securities generally decline. The magnitude of these fluctuations will generally be greater for securities with longer maturities and the FUND expects that its portfolio of U.S. Government Securities will be weighted towards the longer maturities at least to the extent that it has written call options thereon. Although changes in the value of U.S. Government securities will not affect investment income from those securities, they will affect the FUND's net asset value. Investment Grade Fixed Income Securities The FUND may invest in other investment grade U.S. fixed income securities. Such investments may include mortgage related securities that are not U.S. Government Securities, asset backed securities and fixed income securities rated Baa or higher by Moody's Investors Service, Inc. ("Moody's") or BBB by Standard & Poor's Corporation ("Standard & Poor's"). Fixed income securities rated Baa by Moody's or BBB by Standard & Poor's are considered investment grade obligations which lack outstanding investment characteristics and may have speculative characteristics as well. See Appendix A in the FUND's Prospectus for the rating securities descriptions of these rating categories. Mortgage Related Securities Mortgage-related securities issued by financial institutions (or separate trusts or affiliates of such institutions), even where backed by U.S. Government securities, are not considered U.S. Government Securities. The mortgage pass-through market is marked by high liquidity and credit quality. The primary risk that exists for mortgage pass-through securities is interest rate risk. Changes in market yields will affect the value of these securities as the price of fixed income securities generally increases when interest rates decline and decreases when interest rates rise. Prices of longer term securities generally increase or decrease more sharply than those of shorter term securities in response to interest rate changes. In addition, prepayment of -5- principal on mortgage pass-through securities may make it difficult to lock in interest rates for a fixed period of time. To the extent that mortgage securities are purchased at prices that differ from par, these prepayments (which are received at par) may make up a significant portion of the pass-through total return. Generally, mortgage securities yield more than treasury securities of the same average life. Collateralized Mortgage Obligations Collateralized mortgage obligations are debt obligations issued generally by finance subsidiaries or trusts which are secured by mortgage-backed certificates, including GNMA Certificates, FHLMC Certificates and FNMA Certificates, together with certain funds and other collateral. Scheduled distributions on the mortgage-backed certificates pledged to secure the collateralized mortgage obligations, together with certain funds and other collateral and reinvestment income thereon at an assumed reinvestment rate, will be sufficient to make timely payments of interest on the obligations and to retire the obligations not later than their stated maturity. Since the rate of payment of principal of any collateralized mortgage obligation will depend on the rate of payment (including prepayments) of the principal of the mortgage loans underlying the mortgage-backed certificates, the actual maturity of the obligation could occur significantly earlier than its stated maturity. Collateralized mortgage obligations may be subject to redemption under certain circumstances. The rate of interest borne by collateralized mortgage obligations may be either fixed or floating. In addition, certain collateralized mortgage obligations do not bear interest and are sold at a substantial discount (i.e., a price less than the principal amount). Purchases of collateralized mortgage obligations at a substantial discount involves a risk that the anticipated yield on the purchase may not be realized if the underlying mortgage loans prepay at a slower than anticipated rate, since the yield depends significantly on the rate of prepayment of the underlying mortgages. Conversely, purchases of collateralized mortgage obligations at a premium involve additional risk of loss of principal in the event of unanticipated prepayments of the mortgage loans underlying the mortgage-backed certificates since the premium may not have been fully amortized at the time the obligation is repaid. The market value of collateralized mortgage obligations purchased at a substantial premium or discount is extremely volatile and the effects of prepayments on the underlying mortgage loans may increase such volatility. Although payment of the principal of and interest on the mortgage-backed certificates pledged to secure collateralized mortgage obligations may be guaranteed by GNMA, FHLMC or FNMA, the collateralized mortgage obligations represent obligations solely of their issuers and are not insured or guaranteed by GNMA, FHLMC, FNMA or any other governmental agency or instrumentality, or by any other person or entity. The issuers of collateralized mortgage obligations typically have no significant assets other than those pledged as collateral for the obligations. Asset Backed Securities. In general, asset-backed securities in which the FUND may invest are issued as debt securities by special purpose corporations. These securities represent an undivided ownership interest in a pool of installment sales contracts and installment loans collateralized by, among other things, credit card receivables and automobiles. The FUND will invest in, to the extent available, (i) loan pass-through certificates or participations representing an undivided ownership interest in pools of installment sales contracts and installment loans (the "Participations") and (ii) debt obligations issued by special purpose corporations which hold subordinated equity interests in such installment sales contracts and installment loans. The FUND anticipates that a substantial portion of the asset backed securities in which it invests will consist of the debt obligations of such special purpose corporations. Asset-backed securities, in general, are of a shorter maturity (usually five years) than most conventional mortgage-backed securities and historically have been less likely to experience substantial prepayments. Furthermore, the effect of prepayments on securities that have shorter maturities, such as asset-backed securities, is much smaller than the effect of prepayments on securities having longer maturities, such as mortgage-backed securities. The yield characteristics of asset-backed securities differ from more traditional debt securities in that interest and principal payments are paid more frequently, usually monthly, and principal may be prepaid at any time. As a result, if the FUND purchases an asset-backed security at a discount, similar to -6- conventional mortgage-backed securities, a prepayment rate that is faster than expected will increase yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of reducing yield to maturity. Conversely, if the FUND purchases an asset-backed security at a premium, faster than expected prepayments will reduce, while slower than expected prepayments will increase, yield to maturity. Prepayments may result from a number of factors, including trade-ins and liquidations due to default, as well as the receipt of proceeds from physical damage, credit, life and disability insurance policies. The rate of prepayments on asset-backed securities may also be influenced by a variety of economic and social factors, including general measures of consumer confidence; accordingly, from time to time, substantial amounts of prepayments may be available for reinvestment by the FUND and will be subject to the prevailing interest rates at the time of prepayment. Asset-backed securities often contain elements of credit support to lessen the effect of the potential failure by obligors to make timely payments on underlying assets. Credit support falls into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by an obligor on the underlying asset. Liquidity protection ensures that the pass through of payments due on the installment sales contracts and installment loans which comprise the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default enhances the likelihood of ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties; through various means of structuring the transaction, or through a combination of such approaches. The FUND will not pay any additional fees for such credit support. However, the existence of credit support may increase the market price of the security. As with Mortgage-Related Securities, Asset-Backed Securities are often backed by a pool of assets representing the obligations of a number of different parties and use similar credit enhancement techniques. Asset-Backed Securities do not have the benefit of the same security interest in the related collateral as do Mortgage-Related 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 automobile receivables permit the servicers 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 automobile receivables. 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 the automobile receivables may not have a perfected 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. High Yield Securities The FUND may invest up to (but not including) 35% (further limited to the extent of any lower quality fixed income securities held in the International Fixed Income Securities portfolio) of its assets in higher yielding (and, therefore, higher risk), lower rated U.S. corporate fixed income securities, including debt securities, (commonly referred to as "junk bonds") convertible securities and preferred stocks and unrated corporate fixed income securities. Investments in high-yield securities entail greater risks than those involved in higher-rated securities. Convertible securities are bonds, debentures, notes, preferred stock or other securities which may be converted or exchanged by the holder into shares of the underlying common stock at a stated exchange ratio. A convertible security may also be subject to redemption by the issuer but only after a date and under certain circumstances (including a specified price) established on issue. Adjustable rate preferred stocks are preferred stocks which adjust their dividend rates quarterly based on specified relationships to certain indexes of U.S. Treasury Securities. The FUND may continue to hold securities obtained as a result of the conversion of convertible securities held by the FUND when OFFITBANK believes retaining such securities is consistent with the FUND's investment objective. -7- Differing yields on fixed income securities of the same maturity are a function of several factors, including the relative financial strength of the issuers. Higher yields are generally available from securities in the lower categories of recognized rating agencies, i.e., Ba or lower by Moody's or BB or lower by Standard & Poor's. The FUND may invest in any security which is rated by Moody's or by Standard & Poor's, or in any unrated security which OFFITBANK determines is of suitable quality. Securities in the rating categories below Baa as determined by Moody's and BBB as determined by Standard & Poor's are considered to be of poor standing and predominantly speculative. The rating services descriptions of these rating categories, including the speculative characteristics of the lower categories, are set forth in Appendix A in the FUND's Prospectus. Securities ratings are based largely on the issuer's historical financial information and the rating agencies' investment analysis at the time of rating. The medium to lower-rated securities in which the FUND may invest tend to offer higher yields than higher-rated securities with the same maturities because the historical financial condition of the issuers of such securities may not be as strong as that of other issuers. The rating assigned to any particular security, however, is not necessarily a reflection of the issuer's current financial condition, which may be better or worse than the rating would indicate. Although OFFITBANK will consider security ratings when making investment decisions in the High Yield market, it will perform its own investment analysis and will not rely principally on the ratings assigned by the rating services. OFFITBANK's analysis generally may include, among other things, consideration of the issuer's experience and managerial strength, changing financial condition, borrowing requirements or debt maturity schedules, and its responsiveness to changes in business conditions and interest rates. It also considers relative values based on anticipated cash flow, interest or dividend coverage, asset coverage and earnings prospects. High Yield Securities - Risk Factors. High Yield Securities are subject to certain risks that may not be present with investments in higher grade securities. See the FUND's Prospectus for more information. Effect of Interest Rate and Economic Changes. The prices of High Yield Securities tend to be less sensitive to interest rate changes than higher-rated investments, but may be more sensitive to adverse economic changes or individual corporate developments. Periods of economic uncertainty and changes generally result in increased volatility in the market prices and yields of High Yield Securities and thus in the FUND's net asset value. A strong economic downturn or a substantial period of rising interest rates could severely affect the market for High Yield Securities. In these circumstances, highly leveraged companies might have greater difficulty in making principal and interest payments, meeting projected business goals, and obtaining additional financing. Thus, there could be a higher incidence of default. This would affect the value of such securities and thus the FUND's net asset value. Further, if the issuer of a security owned by the FUND defaults, the FUND might incur additional expenses to seek recovery. The High Yield Securities Market. The market for High Yield Securities has expanded in recent years and is relatively new. This expanded market has not yet completely weathered an economic downturn. A further economic downturn or an increase in interest rates could have a negative effect on the High Yield Securities market and on the market value of the High Yield Securities held by the FUND, as well as on the ability of the issuers of such securities to repay principal and interest on their borrowings. Credit Ratings. The credit ratings issued by credit rating services may not fully reflect the true risks of an investment. For example, credit ratings typically evaluate the safety of principal and interest payments, not market value risk, of High Yield Securities. Also, credit rating agencies may fail to change on a timely basis a credit rating to reflect changes in economic or company conditions that affect a security's market value. Liquidity and Valuation. Lower-rated bonds are typically traded among a smaller number of broker-dealers than in a broad secondary market. Purchasers of High Yield Securities tend to be institutions, rather than individuals, which is a factor that further limits the secondary market. To the extent that no established retail secondary market exists, many High Yield Securities may not be as liquid as higher-grade bonds. A less active and thinner market for High Yield Securities than that available for higher quality securities may result in more volatile valuations of the FUND's holding and more difficulty in executing trades at favorable prices during unsettled market conditions. -8- The ability of the FUND to value or sell High Yield Securities will be adversely affected to the extent that such securities are thinly traded or illiquid. During such periods, there may be less reliable objective information available and thus the responsibility of the FUND's Board of Trustees to value High Yield Securities becomes more difficult, with judgment playing a greater role. Further, adverse publicity about the economy or a particular issuer may adversely affect the public's perception of the value, and thus liquidity, of a High Yield Security, whether or not such perceptions are based on a fundamental analysis. Legislation. Provisions of the Revenue Reconciliation Act of 1989 limit a corporate issuer's deduction for a portion of the original issue discount on "high yield discount" obligations (including certain pay-in-kind securities). This limitation could have a materially adverse impact on the market for certain High Yield Securities. In addition, the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 requires savings associations to divest their holdings of High Yield Securities before July 1, 1994. This requirement also could have a materially adverse impact on the market for High Yield Securities. From time to time, legislators and regulators have proposed other legislation that would limit the use of high yield debt securities in leveraged buyouts, mergers and acquisitions. It is not certain whether such proposals, which also could adversely affect High Yield Securities, will be enacted into law. International Fixed Income Securities FUND assets invested in International Fixed Income Securities will be invested in debt obligations and other fixed income securities, in each case denominated in non-U.S. currencies or composite currencies including: debt obligations issued or guaranteed by foreign national, provincial, state, municipal or other governments with taxing authority or by their agencies or instrumentalities; debt obligations or supranational entities (described below); debt obligations of the U.S. Government issued in non-dollar securities; and debt obligations and other fixed income securities of foreign and U.S. corporate issuers (non-dollar denominated). When investing in International Fixed Income Securities, the FUND is not limited to purchasing debt securities rated at the time of purchase by Moody's or Standard & Poor's. However, the FUND is limited to the extent that it may not invest more than 35% of its assets in all lower quality fixed income securities held by the FUND (by aggregating the value of all such securities held in the High Yield Securities and the International Fixed Income Securities portfolios). In making international fixed income securities investments, OFFITBANK may consider, among other things, the relative growth and inflation rates of different countries. OFFITBANK may also consider expected changes in foreign currency exchange rates, including the prospects for central bank intervention, in determining the anticipated returns of securities denominated in foreign currencies. OFFITBANK may further evaluate, among other things, foreign yield curves and regulatory and political factors, including the fiscal and monetary policies of such countries. The FUND may invest in any country where OFFITBANK sees potential for high income. It presently expects to invest primarily in non-dollar denominated securities of issuers in the industrialized Western European countries; in Canada, Japan, Australia and New Zealand; and in Latin America. The FUND may also invest up to 15% of its assets in the fixed income securities of issuers in emerging market countries. See the Fund's Prospectus for more information. The obligations of foreign governmental entities, including supranational issuers, have various kinds of government support. Obligations of foreign governmental entities include obligations issued or guaranteed by national, provincial, state or other governments with taxing power or by their agencies. These obligations may or may not be supported by the full faith and credit of a foreign government. -9- Supranational entities include international organizations designated or supported by governmental entities to promote economic reconstruction or development and international banking institutions and related government agencies. Examples include the International Bank for Reconstruction and Development (the World Bank), the European Steel and Coal Community, the Asian Development Bank and the Inter-American Development Bank. The governmental agencies, or "stockholders," usually make initial capital contributions to the supranational entity and in many cases are committed to making additional capital contributions if the supranational entity is unable to repay its borrowings. Each supranational entity's lending activities are limited to a percentage of its total capital (including "callable capital" contributed by members at the entity's call), reserves and net income. Risk Factors See "Risk Factors - Lower Rated Fixed Income Securities" and Appendix A in the FUND's Prospectus for more information concerning the risks of investing in lower quality fixed income securities. Foreign investments involve certain risks that are not present in domestic securities. Because the FUND intends to purchase securities denominated in foreign currencies, a change in the value of any such currency against the U.S. dollar will result in a corresponding change in the U.S. dollar value of the FUND's assets and the FUND's income available for distribution. In addition, although a portion of the FUND's investment income may be received or realized in such currencies, the Internal Revenue Code of 1986 (the "Code") requires that the FUND compute and distribute its income in U.S. dollars. Therefore, if the exchange rate for any such currency declines after the FUND's income has been earned and translated into U.S. dollars but before payment, the FUND could be required to liquidate portfolio securities to make such distributions. Similarly, if an exchange rate depreciates between the time the FUND incurs expenses in U.S. dollars and the time such expenses are paid, the amount of such currency required to be converted into U.S. dollars in order to pay such expenses in U.S. dollars will be greater than the equivalent amount in any such currency of such expenses at the time they were incurred. Under the Code, changes in an exchange rate which occur between the time the FUND accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time the FUND actually collects such receivables or pays such liabilities will result in foreign exchange gains or losses that increase or decrease distributable net investment income. Similarly, dispositions of certain debt securities (by sale, at maturity or otherwise) at a U.S. dollar amount which is higher or lower than the FUND's original U.S. dollar cost may result in foreign exchange gains or losses, which will increase or decrease distributable net investment income. The values of foreign investments and the investment income derived from them may also be affected unfavorably by changes in currency exchange control regulations. Although the FUND will invest only in securities denominated in foreign currencies that are fully exchangeable into U.S. dollars without legal restriction at the time of investment, there is no assurance that currency controls will not be imposed subsequently. In addition, the values of foreign fixed income investments will fluctuate in response to changes in U.S. and foreign interest rates. There may be less information publicly available about a foreign issuer than about a U.S. issuer, and foreign issuers are not generally subject to accounting, auditing and financial reporting standards and practices comparable to those in the United States. The securities of some foreign issuers are less liquid and at times more volatile than securities of comparable U.S. issuers. Foreign brokerage commissions, custodial expenses and other fees are also generally higher than for securities traded in the United States. In addition, with respect to certain foreign countries, there is a possibility of expropriation of assets, confiscatory taxation, political or financial instability and diplomatic developments which could adversely affect the value of investments in those countries. OFFITBANK does not expect to invest the FUND's assets in countries where it believes such events are likely to occur. Income received by the FUND from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes. OFFITBANK will attempt to minimize such taxes by timing of -10- transactions and other strategies, but there is no assurance that such efforts will be successful. Any such taxes paid by the FUND will reduce its net income available for distribution to shareholders. The FUND is a "non-diversified" investment company portfolio, which means that the FUND is not limited in the proportion of its assets that may be invested in the securities of a single issuer. However, the FUND intends to conduct its operations so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"), which will relieve the FUND of any liability for Federal income tax to the extent its earnings are distributed to shareholders. See "Distributions and Taxes." To so qualify, among other requirements, the FUND will limit its investments so that, at the close of each calendar quarter, (i) not more than 25% of the market value of the FUND's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value of its total assets will be invested in the securities of a single issuer and the FUND will not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the FUND's requirements to maintain diversification for tax purposes, the issuer of a loan participation will be the underlying borrower. In cases where the FUND does not have recourse directly against the borrower, both the borrower and each agent bank and co-lender interposed between the FUND and the borrower will be deemed issuers of the loan participation for tax diversification purposes. The FUND's investments in U.S. Government Securities are not subject to these limitations. Since the FUND as a non-diversified investment company may invest in a smaller number of individual issuers than a diversified investment company, an investment in the FUND may, under certain circumstances, present greater risk to an investor than an investment in a diversified company. Futures Contracts The FUND may enter into contracts for the purchase or sale for future delivery of fixed-income securities or foreign currencies which otherwise meet the FUND's investment policies, to the extent permitted by the Commodity Futures Trading Commission (the "CFTC"). U.S. futures contracts have been designed by exchanges which have been designated "contract markets" by the CFTC, and must be executed through a futures commission merchant, or brokerage firm, which is a member of the relevant contract market. Futures contracts trade on a number of contract markets, and, through their clearing corporations, the exchanges guarantee performance of the contracts as between the clearing members of the exchange. The FUND will enter into futures contracts which are based on debt securities that are backed by the full faith and credit of the U.S. Government, such as Treasury Notes, Government National Mortgage Association modified pass-through mortgage-backed securities and three-month U.S. Treasury Bills. The FUND may also enter into futures contracts which are based on non-U.S. Government bonds. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific, interest rate-sensitive financial instrument (debt security) at a specified price, date, time and place. A foreign currency futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specified foreign currency at a specified price, date, time and place. The FUND may not enter into futures transactions if the sum of the amount of initial margin deposits on its existing futures contracts and premiums paid for unexpired options would exceed 5% of the fair market value of the FUND'S total assets, after taking into account unrealized profits and unrealized losses on commodity contracts it has entered into. The FUND will not use leverage when it enters into long futures or options contracts and for each such long position the FUND will deposit cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, having a value equal to the underlying commodity value of the contract as collateral with its custodian in a segregated account. No consideration is paid or received by the FUND upon entering into a futures contract. Upon entering into a futures contract, the FUND will be required to deposit in a segregated account with its custodian an amount of cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, equal to approximately 1% to 10% of the contract amount (this amount is subject to change by the exchange on which the contract is traded and brokers may charge a higher amount). This amount is known as -11- "initial margin" and 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 broker will have access to amounts in the margin account if the FUND fails to meet its contractual obligations. Subsequent payments, known as "variation margin," to and from the broker, will be made daily as the price of the currency or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract more or less valuable, a process known as "marking-to-market." At any time prior to the expiration of a futures contract, the FUND may elect to close the position by taking an opposite position, which will operate to terminate the FUND's existing position in the contract. There are several risks in connection with the use of futures contracts. Successful use of futures contracts is subject to the ability of FUND management to predict correctly movements in the price of the securities or currencies underlying the particular transaction. These predictions and, thus, the use of futures contracts involve skills and techniques that are different from those involved in the management of portfolio securities. Positions in futures contracts and options on futures contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange). No secondary market for such contracts exists. Although the FUND intends to enter into futures contracts only if there is an active market for such contracts, there is no assurance that an active market will exist for the contracts at any particular time. Most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting the FUND to substantial losses. In such event, and in the event of adverse price movements, the FUND would be required to make daily cash payments of variation margin. Options on Futures Contracts The FUND may purchase and write put and call options on interest rate and foreign currency contracts that are traded on a U.S. exchange or board of trade or a foreign exchange, to the extent permitted by the CFTC, and may enter into closing transactions with respect to such options to terminate existing positions. There is no guarantee that such closing transactions can be effected. An option on an interest rate or foreign currency contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate or foreign currency contract at a specified exercise price at any time prior to the expiration date of the option. Options on interest rate futures contracts currently available include those with respect to U.S. Treasury Bonds, U.S. Treasury Notes, U.S. Treasury Bills and Eurodollars. Options on foreign currency futures currently available include those with respect to British Pounds, Swiss Francs, Japanese Yen, Canadian Dollars and Australian Dollars. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's futures margin account, which represents the amount by which the market price of the futures contracts exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The potential loss related to the purchase of an option on futures contracts is limited to the premium paid for the option (plus transaction costs). Because the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the net asset value of the FUND. Options on Foreign Currencies The FUND may purchase and write options on foreign currencies to increase its gross income in a manner similar to that in which futures contracts on foreign currencies, or forward contracts, will be utilized. -12- The FUND intends to write covered call options on foreign currencies. A call option written on a foreign currency by the FUND is "covered" if the FUND owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its Custodian or by a designated sub-custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the FUND has a call on the same foreign currency and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price or the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the FUND in cash, U.S. Government Securities and other high grade liquid debt securities in a segregated account with its Custodian or with a designated sub-custodian. As a writer of a covered put option, the FUND incurs an obligation to buy the security underlying the option from the purchaser of the put, at the option's exercise price at any time during the option period, at the purchaser's election (certain listed and over-the-counter put options written by the FUND will be exercisable by the purchaser only on a specific date). A put is "covered" if, at all times, the FUND maintains, in a segregated account maintained on its behalf at the FUND's custodian, cash, U.S. Government securities or other high grade obligations in an amount equal to at least the exercise price of the option, at all times during the option period. Similarly, a short put position could be covered by the FUND by its purchase of a put option on the same security (currency) as the underlying security of the written option, where the exercise price of the purchased option is equal to or more than the exercise price of the put written or less than the exercise price of the put written if the marked to market difference is maintained by the FUND in cash, U.S. Government securities or other high grade debt obligations which the FUND holds in a segregated account maintained at its custodian. Forward Currency Contracts The FUND may engage in currency exchange transactions as a portfolio management technique. The FUND will conduct its currency exchange transactions either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through entering into forward contracts to purchase or sell currency. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. If a devaluation is generally anticipated, the FUND may not be able to contract to sell the currency at a price above the devaluation level it anticipates. The FUND will not enter into a currency transaction if, as a result, it will fail to qualify as a regulated investment company under the Code for any given year. Options on Portfolio Securities The FUND may write only covered call option contracts. Currently, the principal exchanges on which such options may be written are the Chicago Board Option Exchange and the American, Philadelphia, and Pacific Stock Exchanges. In addition, the FUND may purchase and sell options in the over-the-counter market ("OTC Options"). A call option gives the purchaser of the option the right to buy the underlying security from the writer at the exercise price at any time prior to the expiration of the contract, regardless of the market price of the security during the option period. The premium paid to the writer is the consideration for undertaking the obligations under the option contract. The writer forgoes the opportunity to profit from an increase in the market price of the underlying security above the exercise price so long as the option remains open and covered, except insofar as the premium represents such a profit. The staff of the Securities and Exchange Commission (the "SEC") has taken the position that purchased over-the-counter options and the assets used as cover for written over-the-counter options are illiquid securities. The FUND will write OTC Options only with primary U.S. Government Securities dealers recognized by the Board of Governors of the Federal Reserve System or member banks of the Federal Reserve System ("primary dealers"). The FUND may also write, to the extent available, OTC Options with non-primary dealers, such as foreign dealers; however, unlike OTC Options written with primary dealers, any OTC Options written with such non-primary dealers and the assets used as cover for such options will be treated as illiquid securities. In connection with these special arrangements, the FUND intends to establish standards -13- for the creditworthiness of the primary and non-primary dealers with which it may enter into OTC Option contracts and those standards, as modified from time to time, will be implemented and monitored by the Manager. Under these special arrangements, the FUND will enter into contracts with primary and non-primary dealers which provide that the FUND has the absolute right to repurchase an option it writes at any time at a repurchase price which represents the fair market value, as determined in good faith through negotiation between the parties, but which in no event will exceed a price determined pursuant to a formula contained in the contract. Although the specific details of the formula may vary between contracts with different primary and non-primary dealers, the formula will generally be based on a multiple of the premium received by the FUND for writing the option, plus the amount, if any, by which the option is "in-the-money." The formula will also include a factor to account for the difference between the price of the security and the strike price of the option if the option is written "out-of-the-money." Under such circumstances, and with respect to OTC Options written with primary dealers only, the FUND will treat as illiquid that amount of the "cover" assets equal to the amount by which the formula price for the repurchase of the option is greater than the amount by which the market value of the security subject to the option exceeds the exercise price of the option (the amount by which the option is "in-the-money"). Although each agreement will provide that the FUND's repurchase price shall be determined in good faith (and that it shall not exceed the maximum determined pursuant to the formula) the formula price will not necessarily reflect the market value of the option written, therefore, the FUND might pay more to repurchase the OTC Option contract than the FUND would pay to close out a similar exchange traded option. In determining the FUND's net asset value, the current market value of any option written by the FUND is subtracted from net asset value. If the current market value of the option exceeds the premium received by the FUND, the excess represents an unrealized loss, and, conversely, if the premium exceeds the current market value of the option, such excess would be unrealized gain. Additional Risks of Options on Futures Contracts, Forward Contracts and Options on Foreign Currencies Unlike transactions entered into by the FUND in certain futures contracts, certain other futures contracts, options on foreign currencies and forward contracts are not traded on contract markets regulated by the CFTC and forward currency contracts are not regulated by the Commission. Instead, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board options Exchange, subject to regulation by the Commission. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the Commission, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the Options Clearing Corporation (the "OCC"), thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the FUND to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special -14- procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, future contracts, options on futures contracts, forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Pursuant to the sub-advisory agreement, OFFITBANK, where permitted by law, will purchase and sell foreign exchange in the interbank dealer market for a fee on behalf of the FUND, subject to certain procedures and reporting requirements adopted by the Board of Trustees. Repurchase Agreements The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans as defined by the Investment Company Act of 1940, as amended (the "1940 Act"), collateralized by the underlying securities. The return on the collateral may be more or less than that from the repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day so that the value of the collateral is at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, OFFITBANK will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. Lending of Portfolio Securities In order to generate additional income, the FUND may lend its portfolio securities in an amount up to 33-1/3% of total FUND assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities. No lending may be made to any companies affiliated with VCM or OFFITBANK. The borrower at all times during the loan must maintain with the FUND cash or cash equivalent collateral or provide to the FUND an irrevocable letter of credit equal in value at all times to at least 100% of the value of the securities loaned. During the time portfolio securities are on loan, the borrower pays the FUND any dividends or interest paid on such securities, and the FUND may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. Loans are subject to termination at the option of the FUND or the borrower at any time. The FUND may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the income earned on the cash to the borrower or placing broker. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. For this -15- purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by the FUND over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 10% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering." Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The SEC has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the -16- FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. The FUND, a non-diversified management investment company, has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having securities of as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within any one industry other than the banking industry (except that this restriction does not apply to U.S. Government Securities); or (d) more than 5% of net assets would be invested in warrants or rights. (Included within that amount, but not to exceed 2% of the value of the FUND's net assets, may be warrants which are not listed on the New York or American Stock Exchanges.) 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 20% of the market value of its total assets). This does not preclude the FUND from obtaining such short-term credit as may be necessary for the clearance of purchases and sales of its portfolio securities. The FUND will not purchase additional securities while the amount of any borrowings is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities except (i) through repurchase agreements, (ii) through loan participations, and (iii) through the lending of its portfolio securities as described in "Lending of Portfolio Securities" in the Prospectus and in this Statement. 5. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities, except as they may be acquired as part of a merger, consolidation or acquisition of assets. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 7. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 8. The FUND may not invest in companies for the purpose of exercising control or management. 9. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 10. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM or OFFITBANK, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. -17- 11. The FUND may not purchase or sell real property (including limited partnership interests, but excluding readily marketable interests in real estate investment trusts or readily marketable securities of companies which invest in real estate). 12. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs or leases. 13. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Manager subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreement between VCM and OFFITBANK. In selecting such brokers or dealers, OFFITBANK will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to OFFITBANK for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to OFFITBANK. Such allocation shall be in such amounts as VCM or OFFITBANK shall determine and OFFITBANK shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to OFFITBANK in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of OFFITBANK's other clients may be useful to OFFITBANK in carrying out its obligations to the FUND. The receipt of such research may not reduce OFFITBANK's normal independent research activities. OFFITBANK is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and OFFITBANK or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from portfolio transactions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the advisory fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between VCM and OFFITBANK does not provide for any reduction in -18- the advisory fees as a result of profits resulting from portfolio transactions effected through OFFITBANK or an affiliated brokerage firm. The Trustees have adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid the Distributor or to OFFITBANK or an affiliated broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. It may happen that the same security will be held by other clients of VCM or of OFFITBANK. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. For the fiscal years ended April 30, 1995 and 1994, the FUND's annual rate of portfolio turnover was approximately 455% and 346%, respectively. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The FUND may invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees. Portfolio securities of the FUND which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, normally 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities -19- for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 p.m. (New York time) will be confirmed at the previous offering price computed as of the close of trading on the options exchanges (normally 4:15 p.m., New York time), provided the order is received by the FUND's Transfer Agent prior to 4:15 p.m. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 p.m. will be confirmed at the next computed offering price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: n P(1 + T) = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. -20- The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the fiscal year ended April 30, 1995 was 3.74% and for the life of fund (November 2, 1992 through April 30, 1995) was 5.64%. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee which was in effect from November 2, 1992 to December 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: 6 YIELD 2[(a-b +1)-1) === cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. Under this formula, interest earned on debt obligations for purposes of "all above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses; however, the FUND will disclose the pro rata share of the account opening fee. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing -21- performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. The FUND's yield as of April 30, 1995, based on a 30-day period, was 6.36%. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to Federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses, including foreign currency gains and loss) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or -22- other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). For purposes of these calculations, gross income includes tax-exempt income. However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received for this purpose by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a forward foreign currency contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Section 1256, will generally be treated as ordinary income or loss. At April 30, 1995, the FUND had a net capital loss carryover of $13,824,044, which is available through April 30, 2003, to the extent provided by regulations. Generally, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contract have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is combined with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. The net amount of such gain or loss for the entire taxable year (including gain or loss arising as a consequence of the year-end deemed sale of such contracts) is treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss (except for Section 1256 forward foreign currency contracts, which are subject to Section 988 Rules). The Internal Revenue Service has held in several private -23- rulings (not necessarily applicable to the FUND) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss, or any net foreign currency loss incurred after October 31 as if they had been incurred in the succeeding year. In addition to satisfying the requirements described above, the fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of its taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will he subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) unless it has made a taxable year election, exclude foreign currency gains and losses incurred after October 31 of any year in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for Federal income tax purposes, but they will not qualify for the 70% dividends-received deduction for corporations. -24- The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consists of the stock or securities of foreign corporations, the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, its pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid its pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against Federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income its pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Shareholders should consult their own tax advisors concerning the application of the foreign tax credit to them. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid by January 31 of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." -25- Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign shareholder would generally be exempt from U.S. Federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. Federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. Federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. Federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the -26- conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. Federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or
-27- Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated
-28- Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds.
-29- Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. -30- Officers and Trustees Compensation
- -------------------------------------------------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. -31- MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the period from November 2, 1992 (commencement of operations) to April 30, 1993, the FUND's investment management fee paid to the prior manager was $433,589 less voluntary expense reimbursement of $433,589. For the fiscal year ended April 30, 1994 the FUND'S investment management fee paid to the prior manager was $4,285,213 less voluntary expense reimbursement of $1,252,529. For the fiscal year ended April 30, 1995, the FUND's investment management fee paid to the prior manager was $2,723,672, less voluntary expense reimbursement of $43,422. THE SUB-ADVISORY AGREEMENT OFFITBANK furnishes investment advisory services to the FUND pursuant to a Sub-Advisory Agreement between VCM and OFFITBANK. Pursuant to the Sub-Advisory Agreement, OFFITBANK supervises the investment and reinvestment of the cash, securities or other properties comprising the FUND's portfolio, subject at all times to the direction of VCM and the policies and control of the Trust's Board of Trustees. OFFITBANK gives the FUND the benefit of its best judgment, efforts and facilities in rendering its services as Sub-Adviser. In carrying out its obligations, OFFITBANK: (a) uses the same skill and care in providing such service as it uses in providing services to fiduciary accounts for which it has investment responsibilities; (b) obtains and evaluates pertinent information about significant developments and economics, statistical and financial data, domestic, foreign or otherwise, whether affecting the economy generally or the FUND's portfolio and whether concerning the individual issuers whose securities are included in the FUND's portfolio or the activities in which the issuers engage, or with respect to securities which it considers desirable for inclusion in the FUND's portfolio; (c) determines which issuers and securities shall be represented in the FUND's portfolio and regularly reports thereon to the Trust's Board of Trustees; (d) formulates and implements continuing programs for the purchases and sales of the securities of such issuers and regularly reports thereon to the Trust's Board of Trustees; (e) is authorized to give instructions to the custodian and/or sub-custodian of the FUND appointed by the Trust's Board of Trustees, as to deliveries of securities, transfers of currencies and payments of cash for the account of the FUND, in relation to the matters contemplated by this Agreement; and (f) takes, on behalf of the FUND, all actions which appear to the Trust and VCM necessary to carry into effect such purchase and sale programs and supervisory functions as aforesaid, including the placing of orders for the purchase and sale of securities for the FUND and the prompt reporting to VCM of such purchases and sales. OFFITBANK is responsible for decisions to buy and sell securities for the FUND's portfolio, broker-dealer selection, and negotiation of brokerage commission rates. OFFITBANK's primary consideration -32- in effecting a security transaction will be execution at the most favorable price. In selecting a broker-dealer to execute each particular transaction, OFFITBANK will take the following into consideration: the best net price available, the reliability, integrity and financial condition of the broker-dealer; the size of and difficulty in executing the order; and the value of the expected contribution of the broker-dealer to the investment performance of the FUND on a continuing basis. Accordingly, the price to the FUND in any transaction may be less favorable than that available from another broker-dealer if the difference is reasonably justified by other aspects of the portfolio execution services offered. Subject to such policies as the Board of Trustees may determine, OFFITBANK shall not be deemed to have acted unlawfully or to have breached any duty created under the Sub-Advisory Agreement or otherwise solely by reason of its having caused the FUND to pay a broker or dealer for effecting a portfolio investment transaction in excess of the amount of commission another broker or dealer would have charged for effecting that transaction, if OFFITBANK determines in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such broker or dealer, viewed in terms of either that particular transaction or OFFITBANK's overall responsibilities with respect to the FUND and to its other clients as to which it exercises investment discretion. Subject to such policies as the Board of Trustees may determine, OFFITBANK will purchase and sell foreign currency and futures contracts and other securities for the FUND. OFFITBANK is further authorized to allocate the orders placed by it on behalf of the FUND to any affiliated broker-dealer of the FUND or to such brokers and dealers who also provide research or statistical material, or other services to the FUND, VCM or OFFITBANK. Such allocation is in such amounts and proportions as OFFITBANK shall determine and OFFITBANK will report on said allocations regularly to the Board of Trustees of the Trust indicating the brokers to whom such allocations have been made and the basis therefor. Any investment program undertaken by OFFITBANK pursuant to the Sub-Advisory Agreement, as well as any other activities undertaken by OFFITBANK on behalf of the FUND pursuant thereto, is at all times subject to any directives of the Board of Trustees of the Trust. VCM provides OFFITBANK with written notice of all such directives, so long as the Sub-Advisory Agreement remains in effect. Pursuant to the Sub-Advisory Agreement, OFFITBANK maintains, at its expense and without cost to VCM or the FUND, a trading function in order to carry out its obligations to place orders for the purchase and sale of portfolio securities for the FUND. Pursuant to the Sub-Advisory Agreement, upon request of VCM and with the approval of the Trust's Board of Trustees, OFFITBANK may perform services on behalf of the FUND which are not required by the Sub-Advisory Agreement. Such services will be performed on behalf of the FUND and OFFITBANK's cost in rendering such services may be billed monthly to VCM, subject to examination by VCM's independent accountants. Payment or assumption by OFFITBANK of any FUND expense that OFFITBANK is not required to pay or assume under the Sub-Advisory Agreement shall not relieve VCM or OFFITBANK of any of their obligations to the FUND or obligate OFFITBANK to pay or assume any similar FUND expense on any subsequent occasions. Pursuant to the Sub-Advisory Agreement, for the services to be rendered and the facilities furnished hereunder, VCM pays OFFITBANK a monthly fee at the annual rate of .30% of the FUND's first $25 million of average daily net assets; plus .25% of the FUND's average daily net assets in excess of $25 million but less than $50 million; plus .20% of the FUND's average daily net assets in excess of $50 million. Compensation under the Sub-Advisory Agreement is calculated and accrued daily and the amounts of the daily accruals are paid monthly. The fee paid to OFFITBANK by the prior manager for the fiscal year ended April 30, 1995 was $763,516, for the fiscal year ended April 30, 1994 was $1,100,253 and $124,403 for the period November 2, 1992 to April 30, 1993. The compensation paid to OFFITBANK will not be reduced by the amount of brokerage commissions received by OFFITBANK or its affiliated broker-dealer pursuant to Section 17(e)(2) of the 1940 Act. Pursuant to the Sub-Advisory Agreement, OFFITBANK agrees that it will not render advisory or sub-advisory services to any other similar publicly offered no-load or low-load open-end investment company registered with the SEC while the Sub-Advisory Agreement is in effect. -33- The Sub-Advisory Agreement was approved by the then Trustees on March 24, 1995. The Sub-Advisory Agreement will remain in force and effect for an initial term of two years, and shall remain in effect thereafter from year to year, provided that such continuance is specifically approved at least annually: (a) (i) by the Trust's Board of Trustees or (ii) by the vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a)(42) of the 1940 Act), and (b) by the affirmative vote of a majority of the Trustees who are not parties to the Sub-Advisory Agreement or interested persons of a party to the Sub-Advisory Agreement (other than as a Trustee of the Trust), by votes cast in person at a meeting specifically called for such purpose. The Sub-Advisory Agreement may be terminated at any time, without the payment of any penalty, by vote of the Trust's Board of Trustees or by vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a) (42) of the 1940 Act), or by VCM or OFFITBANK on sixty (60) days' written notice to the other party. The Sub-Advisory Agreement automatically terminates: (a) in the event of its assignment, the term "assignment" having the meaning defined in Section 2(a)(4) of the 1940 Act, or (b) in the event that the Investment Advisory Contract between the FUND and VCM shall terminate. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for the fees set forth in the prospectus. PURCHASING SHARES Shares of the Fund are sold at their net asset value without a sales charge on days the New York Stock Exchange is open for business. The procedure for purchasing Shares of the Fund is explained in the prospectus under "Investing in Shares." DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Fund; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the Fund accrued payments under the Plan amounting to $907,891. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. -34- By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust." Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the Trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. -35- FINANCIAL STATEMENTS Audited financial statements of the FUND for the fiscal year ended April 30, 1995 are attached hereto. -36- Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Flexible Income Fund for the fiscal year ending April 30, 1995. While 1994 was a very difficult year for virtually every investment market, it was particularly challenging for U.S. bonds, which suffered one of the worst setbacks of the century. Underlying the downturn in bonds was an aggressive series of interest rate hikes by the Federal Reserve. During the fiscal year, the Blanchard Flexible Income Fund's diversified portfolio proved to be both a help and a hindrance. Early on, we correctly anticipated that U.S. rates would almost certainly continue to rise. As a consequence, we used the Fund's flexible portfolio to shift a higher percentage of the Fund's assets out of the U.S. and into high-quality foreign issues. Unexpectedly and unfortunately, overseas markets were also dragged into the U.S. bond debacle, causing our portfolio additional losses. In short, there were almost no safe havens available for bond investors. In the last quarter of 1994, our analysis told us that rates had moved too far, too fast. As a result, we began to extend the average maturity and effective duration of the portfolio in an attempt to regain lost ground. This strategy paid off handsomely through April 30, 1995, the (over, please) The following information was represented as a line graph - -------------------------------------------------------------------------------- The Value of a $10,000 Investment in the Blanchard Flexible Income Fund inception 11/2/92 through 4/30/95 as compared to the Merrill Lynch Aggregate Bond Index for the same period --------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Flexible Income Fund* --------------------------------------- 1 year 3.74% --------------------------------------- since inception 5.64% --------------------------------------- FYE 4/30/93 FYE 4/30/94 FYE 4/30/95 FIF 6.17% 4.11% 3.74% MERRILL LYNCH 6.52% 1.04% 7.34% $9,925 $10,537 $10,970 $11,381 $10,000 $10,652 $10.763 $11,553 Reflects deduction of $75 acct opening fee Blanchard Merrill Lynch Flexible Income Aggregate Bond Fund^ Index(D) *The average annual returns quoted reflect reinvestment of distributions, but do not reflect the deduction of the one-time account opening fee. If reflected, the returns would be lower. The total return includes changes in principal value. The average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: Merrill Lynch Aggregate Bond Index is an unmanaged index of government, investment grade, corporate and mortgaged-backed bonds. ^Reflects deduction of one-time account opening fee of $75. This chart is for comparative purposes only and is not intended to reflect on future performance of the index or the BFIF. - -------------------------------------------------------------------------------- end of the fiscal year, with the Fund showing a positive return of 3.74%. Of course, past performance is no guarantee of future results. As with any investment, the Fund's yield and principal value will vary so that shares, when redeemed, may be worth more or less than their original purchase price. As the fiscal year came to a close, the Fund's portfolio was allocated across four sectors: 63% U.S. fixed-income securities, 30% U.S. high-yield, 4% high-quality foreign and 3% U.S. cash equivalents. Throughout the period, we maintained our commitment to high quality securities, reflected in the Fund's "A" rated average portfolio quality. Looking Ahead Due to the strong rebound in bond prices in the first part of 1995, we have become somewhat cautious on a short-term basis. As a result, the Fund's portfolio remains invested in the intermediate-term range of the bond spectrum. This allows us to earn higher yields than short-term instruments, without the same degree of risk entailed by longer-term bond investments. Longer-term, however, we believe that interest rates have settled in a lower range than they have been in several years. While inflation may move somewhat higher, we do not believe it will do so to any significant degree. In essence, we are currently enjoying what a number of analysts have come to call a "soft landing." In simple terms, this means that while U.S. economic activity will most likely regain some momentum, helped along by the recent decline in interest rates and by a decline in the value of the dollar, any such expansion should not accelerate to a worrisome level in the foreseeable future. We thank you for your continued patronage and look forward to serving you in the months and years ahead. Sincerely, JB:ml Jack Burks Managing Director of OFFITBANK Portfolio Managers of the Blanchard Flexible Income Fund Distributed by Sheffield Investments, Inc. (1551) 01ARSL0695 BLANCHARD FLEXIBLE INCOME FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Principal Value --------- ----- U.S. FIXED INCOME SECURITIES SECTOR (67.59%) CORPORATE BONDS (5.43%) Airlines (.49%) Delta Airlines Inc. Series 1992 D 8.54%, 1/2/07 ........................... $ 1,267,404 $ 1,274,067 ------------ Banking (.46%) (D)Buenos Aires Embottelladora 8.50%, 12/29/00 ......................... 1,500,000 1,215,000 ------------ Financial Services (1.66%) Leucadia National Corp. 10.375%, 6/15/02 ........................ 4,050,000 4,353,750 ------------ Healthcare (.88%) Omega Healthcare Investors Inc. 7.11%, 7/15/00 .......................... 2,394,385 2,310,199 ------------ Industrial Related (1.56%) PDV America Inc. 7.25%, 8/1/98 ........................... 2,250,000 2,051,287 Stone Consolidated Corp. 10.25%, 12/15/00 ........................ 2,000,000 2,050,000 ------------ 4,101,287 ------------ Real Estate (.38%) Kearny Street Real Estate LP Cl. D 9.56%, 7/15/03 .......................... 1,000,000 999,687 ------------ TOTAL CORPORATE BONDS ............................... 14,253,990 ------------ U.S. GOVERNMENT AND AGENCY ISSUES (62.16%) Federal National Mortgage Association 8.20%, 8/10/98 .......................... 5,000,000 5,035,065 *Federal National Mortgage Association 8.625%, 4/10/01 ......................... 10,000,000 10,206,550 Government National Mortgage Association 8%, 11/15/19 ............................ 373,708 373,474 Government National Mortgage Association 8%, 1/15/20 ............................. 317,317 317,119 Government National Mortgage Association 8%, 8/15/21 ............................. 130,496 130,415 Government National Mortgage Association 8%, 2022 ................................ 24,225,691 24,210,549 Government National Mortgage Association 8%, 2023 ................................ 2,282,196 2,280,768 (Right Column) Principal Value --------- ----- Government National Mortgage Association 8%, 6/15/24 ............................. $ 2,373,713 $ 2,372,229 Government National Mortgage Association II 8%, 7/20/21 ............................. 2,390,630 2,380,171 Government National Mortgage Association II 8%, 5/20/22 ............................. 2,077,866 2,068,775 Government National Mortgage Association II 8%, 2023 ................................ 5,215,589 5,192,771 (D)Resolution Trust Corp. 10.50%, 10/15/03 ........................ 2,000,000 1,999,375 (D)Resolution Trust Corp. 6%, 1/15/04 ............................. 750,000 749,063 (D)Resolution Trust Corp. 10.50%, 1/15/04 ......................... 1,250,000 1,253,125 (c)(D)Resolution Trust Corp. 10%, 12/15/04 ........................... 1,500,000 1,499,531 Resolution Trust Corp. 7.10%, 12/25/24 ......................... 2,639,001 2,325,620 U.S. Treasury Note 7.50%, 2/29/96 .......................... 25,000,000 25,234,375 U.S. Treasury Note 6.875%, 10/31/96 ........................ 25,000,000 25,125,000 U.S. Treasury Note 6.875%, 8/31/99 ......................... 25,000,000 25,031,250 U.S. Treasury Note 7.25%, 5/15/04 25,000,000 25,320,300 ------------ TOTAL U.S. GOVERNMENT AND AGENCY ISSUES ....................... 163,105,525 ------------ TOTAL U.S. FIXED INCOME SECURITIES SECTOR (IDENTIFIED COST $179,212,597) ............................... 177,359,515 ------------ FOREIGN FIXED INCOME SECURITIES SECTOR (1.87%) GOVERNMENT/AGENCY (1.87%) GERMANY (1.87%) Bundesrepublic 8.25%, 9/20/01 .......................... Dm 6,330,000 4,911,624 ------------ TOTAL FOREIGN FIXED INCOME SECURITIES SECTOR (IDENTIFIED COST $4,796,617) ...................... 4,911,624 ------------ 3 BLANCHARD FLEXIBLE INCOME FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) (Left Column) Principal Value --------- ----- HIGH YIELD SECTOR (27.67%) CANADA (.95%) Telecommunications (.95%) Rogers Cable Systems 9.65%, 1/15/14 .......................... C$ 4,000,000 $ 2,485,750 ------------ U.S. CORPORATE BONDS (26.72%) Airlines (1.03%) Piedmont Aviation Inc. 9.90%, 1/15/01 .......................... $ 852,000 760,410 Piedmont Aviation Inc. 10.15%, 3/28/03 ......................... 1,389,000 1,152,870 U.S. Air Inc. Series B 9.90%, 1/15/01 .......................... 896,000 799,680 ------------ 2,712,960 ------------ Basic Materials (2.92%) Bethlehem Steel Corp. 10.375%, 9/01/03 ........................ 1,500,000 1,552,500 Doman Industries, Ltd. 8.75%, 3/15/04 .......................... 1,500,000 1,406,250 Jorgensen Earle M. Co. 10.75%, 3/01/00 ......................... 1,500,000 1,447,500 Maxxam Group Inc. 11.25%, 8/01/03 ......................... 1,500,000 1,417,500 Northwestern Steel & Wire 9.50%, 6/15/01 .......................... 2,000,000 1,840,000 ------------ 7,663,750 ------------ Consumer Related (3.43%) Bradlees, Inc. 9.25%, 3/01/03 .......................... 1,500,000 1,218,750 Levitz Furniture Corp. 9.625%, 7/15/03 ......................... 1,500,000 1,117,500 Pathmark Stores Inc. 9.625%, 5/01/03 ......................... 1,800,000 1,737,000 Penn Traffic Co. 10.25%, 2/15/02 ......................... 1,750,000 1,785,000 Revlon Consumer Products Corp. 9.375%, 4/01/01 ......................... 1,000,000 960,000 Revlon Inc. 10.875%, 7/15/10 ........................ 960,000 926,400 U.S. Leather Inc. 10.25%, 7/31/03 ......................... 1,500,000 1,252,500 ------------ 8,997,150 ------------ Electronics (.56%) Bell & Howell Co. 9.25%, 7/15/00 .......................... 1,500,000 1,466,250 ------------ (Right Column) Principal Value --------- ----- Energy & Oil Related (3.19%) CTC Mansfield Funding Inc. 10.25%, 3/30/03 ......................... $ 2,000,000 $ 1,966,910 Maxus Energy Corp. 11.02%, 5/15/01 ......................... 2,000,000 1,915,000 Triton Energy Corp. 0% until 12/15/96, 9.75% until maturity, 12/15/00 ................ 1,500,000 1,263,750 Triton Energy Corp. 10.45%(e), 11/1/97 ...................... 1,500,000 1,196,250 (b)Tucson Electric Power 10.21%, 1/01/09 ......................... 2,218,808 2,019,116 ------------ 8,361,026 ------------ Financial Services (4.03%) American Annuity Group Inc. 11.125%, 2/01/03 ........................ 1,000,000 1,037,500 Americo Life Inc. 9.25%, 6/01/05 .......................... 2,000,000 1,790,000 (b)Granite Development Partners 10.83%, 11/15/03 ........................ 1,750,000 1,596,875 Lomas Mortgage USA Inc. 10.25%, 10/01/02 ........................ 1,000,000 745,000 Navistar Financial Group 8.875%, 11/15/98 ........................ 1,500,000 1,477,500 Phoenix Re Corp. 9.75%, 8/15/03 .......................... 1,250,000 1,300,000 Presidential Life 9.50%, 12/15/00 ......................... 1,500,000 1,447,500 Reliance Group Holdings Inc. 9%, 11/15/00 ............................ 1,250,000 1,192,188 ------------ 10,586,563 ------------ Industrial Related (8.68%) (b)ACF Industries Inc. 12.50%, 2/01/98 ......................... 800,333 800,333 ADT Operations Inc. 9.25%, 8/01/03 .......................... 1,500,000 1,507,500 Armco Inc. 9.375%, 11/01/00 ........................ 2,000,000 1,895,000 CMI Industries, Inc. 9.50%, 10/01/03 ......................... 1,500,000 1,308,750 Eletson Holdings Inc. 9.25%, 11/15/03 ......................... 1,500,000 1,428,750 EnviroSource, Inc. 9.75%, 6/15/03 .......................... 1,500,000 1,346,250 Freeport-McMoran Resources Partners 8.75%, 2/15/04 .......................... 1,500,000 1,436,250 Owens-Illinois, Inc. 10%, 8/01/02 ............................ 3,000,000 3,063,750 Riverwood Int'l Corp. 10.75%, 6/15/00 ......................... 1,250,000 1,325,000 Sequa Corp. 8.75%, 12/15/01 ......................... 3,000,000 2,823,750 4 BLANCHARD FLEXIBLE INCOME FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) (Left Column) Principal Value --------- ----- Stone Container Corp. 9.875%, 2/01/01 ......................... $ 2,500,000 $ 2,496,875 Tracor, Inc. 10.875%, 8/15/01 ........................ 1,500,000 1,541,250 UNC Inc. 9.125%, 7/15/03 ......................... 2,000,000 1,810,000 ------------ 22,783,458 ------------ Telecommunications (2.23%) Cablevision Industries Corp. 10.75%, 1/30/02 ......................... 1,200,000 1,285,500 Cablevision Systems Sr. Deb. Notes 10.75%, 4/01/04 ......................... 1,500,000 1,573,125 MFS Communications 0% until 1/15/99, 9.375% until maturity, 1/15/04 ................. 2,500,000 1,656,250 Paging Network Inc. 8.875%, 2/01/06 ......................... 1,500,000 1,336,875 ------------ 5,851,750 ------------ Transportation (.65%) Sea Containers Ltd. 9.50%, 7/01/03 .......................... 1,800,000 1,703,250 ------------ TOTAL HIGH YIELD SECTOR (IDENTIFIED COST $77,128,463) .......................... 72,611,907 ------------ (Right Column) Principal Value --------- ----- SHORT-TERM SECURITIES (1.14%) Associates Corp. of N.A. 5.80%, 5/01/95 .......................... $ 3,000,000 $ 3,000,000 ------------ TOTAL SHORT-TERM SECURITIES (IDENTIFIED COST $3,000,000) ........................... 3,000,000 ------------ TOTAL INVESTMENTS (IDENTIFIED COST $264,137,677) (a) (98.27%) .............................. 257,883,046 EXCESS OF CASH AND OTHER ASSETS OVER LIABILITIES (1.73%) ................... 4,540,038 ------------ NET ASSETS (100%) ....................... $262,423,084 ============ (a) The aggregate cost for federal income tax purposes is $264,139,976; the gross unrealized appreciation is $820,451; and the gross unrealized depreciation is $7,077,381; resulting in net unrealized depreciation of $6,256,930. (b) Private placement, resale restricted as to accredited buyers; represents 1.68% of net assets. (c) Variable rate security. Interest rate shown reflects current interest rate as of 4/30/95. * Portion of security segregated to collateralize forward currency contracts. Total market value segregated is $173,511. (D) Registered under SEC rule 144-A, resale restricted as to qualified institutional buyers; represents 2.56% of net assets. 5 BLANCHARD FLEXIBLE INCOME FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) SCHEDULE OF OPEN FORWARD CURRENCY CONTRACTS AS OF APRIL 30, 1995
Unrealized Currency Currency Appreciation Sold Amount Purchased Amount Delivery Date (Depreciation) - ------------------------------------------------------------------------------------------- Deutsche Marks 7,140,000 USD 5,250,000 May 22, 1995 $ 95,286 -------- Total Unrealized Appreciation $ 95,286 ======== Canadian Dollars 3,450,000 USD 2,448,893 May 31, 1995 $(84,333) -------- Total Unrealized Depreciation $(84,333) ========
See notes to financial statements. 6 BLANCHARD FLEXIBLE INCOME FUND Statement of Assets and Liabilities April 30, 1995 Assets: Investments in securities, at value (Identified Cost $264,137,677)(note 1) ................. $257,883,046 Cash ....................................................................................... 302,813 Receivables for: Interest ................................................................................. 5,354,353 Investments sold ......................................................................... 333,750 Forward currency contracts ............................................................... 95,286 Shares of beneficial interest sold ....................................................... 92,438 Deferred organization expense (note 1) ..................................................... 75,862 ------------ Total assets ......................................................................... 264,137,548 ------------ Liabilities: Payables for: Shares of beneficial interest repurchased ................................................ 888,268 Dividends ................................................................................ 253,984 Forward currency contracts ............................................................... 84,333 Accrued expenses and other liabilities ....................................................... 487,879 ------------ Total liabilities .................................................................... 1,714,464 ------------ Net assets ........................................................................... $262,423,084 ============ Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 55,757,152 shares outstanding) ............................................................. $287,964,673 Accumulated overdistributed net investment income ............................................ (742,594) Accumulated realized loss .................................................................... (18,559,663) Unrealized net depreciation of investments, forward currency contracts and net currency translation adjustments ................................................... (6,239,332) ------------ Net assets ................................................................................... $262,423,084 ============ Net asset value per share .................................................................... $4.71 =====
See notes to financial statements. 7 BLANCHARD FLEXIBLE INCOME FUND Statement of Operations For the Year Ended April 30, 1995 Investment Income: Interest .................................................................................. $ 29,159,495 Dividends ................................................................................. 235,141 ------------ Total income .............................................................................. 29,394,636 Expenses: Investment management fee (note 2) ........................................................ 2,723,672 Transfer agent fees (note 5) .............................................................. 1,007,226 Plan of distribution fees (note 3) ........................................................ 907,891 Trustees' fees, retirement plan curtailment and other expenses (note 5) ................... 414,054 Accounting fees (note 5) .................................................................. 245,131 Professional fees ......................................................................... 161,461 Custodian fees ............................................................................ 134,387 Shareholder reports and notices ........................................................... 126,400 Organizational expenses ................................................................... 30,343 Registration fees ......................................................................... 6,006 Other ..................................................................................... 14,394 ------------ Total expenses ........................................................................ 5,770,965 Less: Fund expenses voluntarily waived by the Manager (note 2) ........................ (43,422) ------------ Net expenses .......................................................................... 5,727,543 ------------ Investment income-net ................................................................. 23,667,093 ------------ Realized and unrealized gain (loss)-net (note 1): Realized gain (loss) on: Investments in securities-net ........................................... $(16,882,946) Forward currency contracts and foreign exchange transactions-net ................................... (8,767,481) (25,650,427) ------------ Change in unrealized appreciation or depreciation on: Investments-net ......................................................... 6,551,880 Forward currency contracts and translation of other assets and liabilities denominated in foreign currencies-net ................... 2,485,477 9,037,357 ------------- ------------ Net realized and unrealized losses ..................................... (16,613,070) ------------ Net increase in net assets resulting from operations ................... $ 7,054,023 ============
See notes to financial statements. 8 BLANCHARD FLEXIBLE INCOME FUND Statement of Changes in Net Assets
For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income-net ........................................................ $ 23,667,093 $ 40,572,006 Realized loss-net ............................................................ (25,650,427) (7,041,662) Change in unrealized appreciation or depreciation-net ........................ 9,037,357 (19,567,492) ------------ ------------ Net increase in net assets resulting from operations ......................... 7,054,023 13,962,852 ------------ ------------ Dividends and distributions to shareholders: Investment income-net ........................................................ (178,445) (39,977,383) Realized gain on investments and foreign exchange transactions- net ........................................................................ - (8,430,223) Tax return of capital ........................................................ (23,736,224) (2,919,905) ------------ ------------ (23,914,669) (51,327,511) ------------ ------------ Transactions in shares of beneficial interest-net increase (note 6) ..................................................................... (270,970,395) 271,774,153 ------------ ------------ Net increase (decrease) in net assets .......................................... (287,831,041) 234,409,494 Net assets: Beginning of year .............................................................. 550,254,125 315,844,631 ------------ ------------ End of period (including overdistribution of investment income - net of $742,594 and $15,600,252, respectively) ...................................... $262,423,084 $550,254,125 ============ ============ - ---------- *Commencement of operations.
See notes to financial statements. 9 NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard Flexible Income Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940, as amended (the "Act"). The Fund had no operations before November 2, 1992 other than the sale of 500,000 and 100,000 shares of beneficial interest for $2,500,000 and $500,000 to Sheffield Management Company (the "Manager") and OFFITBANK (the "Portfolio Adviser"), respectively. Approximately 104,300 shares were held by OFFITBANK at April 30, 1995. The Manager redeemed its shares of the Fund prior to April 30, 1993. The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. The ability of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a particular country, industry or region. The Fund invests a portion of its assets in high yield securities, which may be subject to a greater degree of credit risk, greater market fluctuations and risk of loss of income and principal, and may be more sensitive to economic conditions than lower yielding, higher rated fixed income securities. B. Accounting for Investments and Security Income Transactions-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date, except that certain dividends from foreign securities are recorded as soon as the Fund is informed after the ex-dividend date. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Contracts & Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rates at the end of the period; and (2) purchases, sales, income and expenses are translated at the exchange rates prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from changes in market prices of equity investments during the period. 10 BLANCHARD FLEXIBLE INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) However, in accordance with the requirements of the Internal Revenue Code, the Fund isolates the effect of changes in foreign exchange rates from the fluctuations arising from changes in market prices of foreign debt obligations sold, and such net foreign exchange gains, which amounted to $913,641, are included in ordinary income for federal income tax purposes and have been reclassified from realized gain (loss) on investments in securities-net to realized gain (loss) on forward currency contracts and foreign exchange transactions-net in the Statement of Operations. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future exchange rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. The Fund generally enters into a forward currency contract as a hedge against foreign exchange rate fluctuation upon the purchase or sale of a security denominated in a foreign currency. The Fund maintains, as collateral, U.S. Government debt obligations in an amount equal to or greater than its net obligation for forward currency contracts. Risks may arise as a result of the potential inability of the counterparties to meet the terms of their contracts. D. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. E. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in-capital. F. Organizational Expenses-The Fund's Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to approximately $151,712. The Fund has reimbursed the Manager for such expenses and has deferred and is amortizing such expenses over five years from the date of commencement of the Fund's operations. G. Other-Certain expenses of the Blanchard Group of Funds are allocated among the funds based upon their relative average net assets. 11 BLANCHARD FLEXIBLE INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of .75% of the Fund's average daily net assets. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses, are subject to the expenses limitation imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed the above limitation. Certain officers and/or Trustees of the Fund are officers and/or directors of the Manager. The Manager has a sub-advisory agreement with OFFITBANK (the "Portfolio Adviser"). The Manager has advised the Fund that fees paid to the Portfolio Adviser were $763,516 for the year ended April 30, 1995. The Manager voluntarily waived a portion of its advisory fee, which amounted to $43,422, for the year ended April 30, 1995. Although not required to do so pursuant to the Management Agreement and Distribution plan in effect between the Fund and its Manager and Sheffield Investments, Inc. (the "Distributor"), respectively, the Manager and the Distributor voluntarily agreed that they will defer receipt of all fees payable to them and absorb a portion of other expenses until further notice. Such deferred fees and expense absorptions are subject to later reimbursement. The Manager and the Distributor have conditioned their right to receive a portion of any earned but deferred fees and to receive reimbursement for absorbed expenses (measured on a rolling two-year period, starting from the date the portion of the fees is deferred and/or the expenses are absorbed) upon the Fund reaching and maintaining the following specified levels of net assets for a period of 30 continuous days (excluding assets exchanged into the Fund from other Funds in the Blanchard Group of Funds) provided that such reimbursement would not cause the Fund's expenses in such year to exceed 1.75% of average daily net assets. Specified Level of Conditional Portion of Earned Fund's Net Assets But Deferred Fees to be Received ------------------ -------------------------------- $600 million 20% $630 million 20% $660 million 20% $690 million 20% $720 million 20% --- 100% === Subject to this agreement, $812,466 was deferred in fiscal 1993; of this amount $626,264 was subsequently paid to the Manager and Distributor and $92,992 was permanently waived in fiscal 1994. The remaining $93,210 of deferred fees were permanently waived in fiscal 1995. 12 BLANCHARD FLEXIBLE INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, the Distributor, an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .25% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after November 2, 1992, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $1,226,849. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Flexible Income Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2)a new distribution agreement with Federated Securities Corp., and (3)certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $1,540,462,073 and $1,793,389,386, respectively, including purchases and sales of U.S. Government obligations of $1,496,807,306 and $1,478,281,217, respectively. The Distributor has advised the Fund that it received $23,400 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that, for the year ended April 30, 1995, it incurred costs, amounting to $398,607, which were reimbursed by the Fund, for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 13 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees' fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $75,829. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $286,788 was recorded to reflect the previously unrecognized prior service costs of the independent director/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $362,617 of accrued pension expense.
NOTE 6 - Shares of Beneficial Interest: For the Year Ended For the Year Ended April 30, 1995 April 30, 1994 ----------------------- ----------------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold ............................. 22,941,483 $ 107,867,527 149,630,745 $ 770,376,313 Reinvestment of dividends and distributions .................. 4,034,188 18,885,949 8,398,329 42,998,080 ----------- ------------- ----------- ------------- 26,975,671 126,753,476 158,029,074 813,374,393 Repurchased ...................... (84,785,272) (397,723,871) (106,481,507) (541,600,240) ----------- ------------- ----------- ------------- Net increase (decrease) .......... (57,809,601) $(270,970,395) 51,547,567 $ 271,774,153 =========== ============= =========== =============
NOTE 7 - Federal Income Tax: Any capital loss incurred after October 31 through the end of the Fund's taxable year is deemed to arise on the first day of the Fund's next taxable year, if so elected. The Fund elected to defer a net capital loss of $4,733,320 incurred during such period in fiscal 1995. As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to wash sales and post-October capital loss deferrals. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $23,882,654, accumulated realized loss-net was debited $8,777,420 and accumulated distributions in excess of investment income-net was debited $15,105,234. At April 30, 1995, the Fund had a net capital loss carryover of $13,824,044, which is available through April 30, 2003 to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distirbuted to shareholders. 14 BLANCHARD FLEXIBLE INCOME FUND NOTES TO FINANCIAL STATEMENTS (continued) NOTE 8 - Financial Highlights:
Selected ratios and per share data for a share of For the period beneficial interest outstanding: November 2, 1992 (commencement of For the Year Ended operations) to April 30, April 30, ------------------ 1995 1994 1993 ---- ---- ---- Per Share Operating Performance: Net asset value, beginning of period ........... $4.85 $5.09 $5.00 ----- ----- ----- Income from investment operations: Net investment income ........................ .30(4) .40 .21 Net gains or losses on securities (both realized and unrealized) ............. (.13) (.17) .09 ----- ----- ----- Net income from investment operations ........................... .17 .23 .30 ----- ----- ----- Less dividends and distributions: Dividends from investment income ............. (.00)(5) (.36) (.21) Distributions from realized gains on investments and foreign exchange transactions-net ........................... .00 (.08) .00 Tax return of capital ........................ (.31) (.03) .00 ----- ----- ----- Change in net asset value .............. (.14) (.24) .09 Net asset value, end of period ................. $4.71 $4.85 $5.09 ===== ===== ===== Total return ................................... 3.74% 4.11% 6.17%(3) Ratios/Supplemental Data: Net assets, end of period ($ Million) ........ 262 550 316 Ratio of expenses to average net assets(2) ... 1.58% 1.30% .20% Ratio of net investment income to average net assets(2) ...................... 6.52% 7.10% 9.02% Portfolio turnover ............................. 455% 346% 129% - ---------- (1) Annualized. (2) The ratios of expenses to average net assets and net investment income to average net assets would have been 1.59% and 6.51%, respectively, for the year ended April 30, 1995, and 1.41% and 6.99%, respectively, for the year ended April 30, 1994 and 1.59% and 7.62%, respectively, for the period ended April 30, 1993, if a portion of the Fund's expenses had not been voluntarily deferred and absorbed by the Manager (See note 2). (3) Not annualized. (4) Calculated based on average shares outstanding. (5) Less than one cent per share.
15 BLANCHARD FLEXIBLE INCOME FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Flexible Income Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Flexible Income Fund (the "Fund") at April30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the two years in the period then ended and for the period November 2, 1992 (commencement of operations) through April 30, 1993, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as " financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 16 (Left Column) Portfolio Adviser OFFITBANK Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Flexible Income Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Flexible Income Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD SHORT-TERM BOND FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Short-Term Bond Fund (the "FUND") is offered. Please retain this document for future reference. To obtain the Prospectus please call the FUND at 1-800-829-3863 TABLE OF CONTENTS Page General Information and History ............................................ 2 Investment Objective and Policies .......................................... 2 Securities in Which the FUND May Invest .................................... 3 Investment Restrictions .................................................... 16 Portfolio Transactions ..................................................... 18 Computation of Net Asset Value ............................................. 19 Performance Information .................................................... 20 Additional Purchase and Redemption Information ............................. 22 Tax Matters ................................................................ 22 The Management of the FUND ................................................. 27 Management Services ........................................................ 32 The Sub-Advisory Agreement ................................................. 33 Administrative Services .................................................... 35 Distrtibution Plan ......................................................... 35 Description of the FUND .................................................... 35 Shareholder Reports ........................................................ 36 Financial Statements ....................................................... 36 Manager Virtus Capital Management, Inc. Sub-Adviser OFFITBANK Distributor Federated Services Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. The FUND's investment objective is to provide a high level of current income consistent with preservation of capital by investing primarily in a broad range of short-term debt securities. There is no assurance that the FUND will achieve its investment objective. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with, the sections in the FUND's Prospectus entitled "Investment Objective and Policies," "Certain Portfolio Securities" and "Certain Investment Strategies and Policies." Under normal market conditions, the FUND will invest at least 80% of its assets in a broad range of U.S. debt securities of all types. The FUND may invest up to 20% of the value of its assets in securities of foreign issuers denominated in foreign currency and not publicly traded in the United States. At least 65% of the value of the FUND's assets will be invested in investment-grade debt securities, which are considered to be those rated at least Baa by Moody's Investors Service, Inc. ("Moody's") or at least BBB by Standard & Poor's Corporation ("Standard & Poor's") or, if unrated, deemed to be of comparable quality by OFFITBANK. The FUND may invest up to 35% of its assets in lower-quality debt securities if OFFITBANK deems that such securities present attractive investment opportunities. The FUND will not invest in debt securities rated lower than Caa by Moody's and CCC by Standard & Poor's, or, if unrated, are of comparable quality in OFFITBANK's opinion. Debt securities rated Baa by Moody's and BBB by Standard & Poor's are considered investment grade obligations which lack outstanding investment characteristics and may have speculative characteristics as well. Debt securities rated Caa by Moody's and CCC by Standard & Poor's are considered to have predominantly speculative characteristics with respect to capacity to pay interest and repay principal and to be of poor standing. See "Risk Factors -- Lower Quality Securities" and Appendix A in the FUND's Prospectus. Normally, the dollar-weighted average maturity of the FUND's portfolio will be less than three years, but will never exceed five years. However, the FUND may invest in individual securities with terms to maturity of greater than five years if the FUND's portfolio contains sufficient short-term securities so that the weighted average maturity complies with the above-stated policy. As the useful life of individual pools of assets underlying certain obligations in which the Fund may invest may at times be of a shorter duration than the stated maturity of the obligation itself, the Fund may consider the useful life of such underlying assets as the maturity of the obligation owned by the Fund. Although it is intended that the average maturity of the FUND's portfolio will be three years or less, the FUND retains the flexibility to increase the average maturity up to five years if OFFITBANK considers it appropriate or advantageous to investors. Accordingly, the FUND's average maturity may vary, based on OFFITBANK's analysis of interest rate trends and other data. In general, the FUND's average maturity will tend to be shorter when OFFITBANK expects interest rates to rise and longer when it expects interest rates to decline. Under normal market conditions, the FUND does not expect to have a substantial portion of its assets invested in money market instruments. However, when OFFITBANK determines that adverse market conditions exist, the FUND may adopt a temporary defensive posture and invest its entire portfolio in money market instruments. To the extent the FUND is so invested, the FUND's investment objective may not be achieved. -2- SECURITIES IN WHICH THE FUND MAY INVEST The FUND's portfolio may include, in any proportion, bonds, notes, mortgage securities, asset-backed securities, government and government agency obligations, zero coupon securities and convertible securities, and short-term obligations such as bankers' acceptances, certificates of deposit, repurchase agreements and commercial paper. The FUND may invest in U.S. government securities and in options, futures contracts and repurchase transactions with respect to such securities. Certain of these obligations including U.S. Treasury bills, notes and bonds, mortgage participation certificates guaranteed by the Government National Mortgage Association ("GNMA"), and Federal Housing Administration debentures, are supported by the full faith and credit of the United States. Other U.S. government securities issued or guaranteed by Federal agencies or government sponsored enterprises are not supported by the full faith and credit of the United States. These securities include obligations supported by the right of the issuer to borrow from the U.S. Treasury, such as obligations of Federal Home Loan Banks, and obligations supported only by the credit of the instrumentality, such as Federal National Mortgage Association Bonds. When purchasing securities in the U.S. government market, OFFITBANK may take full advantage of the entire range of maturities of U.S. government securities and may adjust the average maturity of the investments held in the portfolio from time to time, depending on its assessment of relative yields of securities of different maturities and its expectations of future changes in interest rates. To the extent that the FUND invests in the mortgage market, OFFITBANK usually will evaluate, among other things, relevant economic, environmental and security-specific variables such as housing starts, coupon and age trends. To determine relative value among markets OFFITBANK may use tools such as yield/duration curves, break-even prepayment rate analysis and holding-period-return scenario testing. The FUND may seek to increase its current income by writing covered call or put options with respect to some or all of the U.S. government securities held in its portfolio. In addition, the FUND may at times, through the writing and purchase of options on U.S. government securities, and the purchase and sale of futures contracts and related options with respect to U.S. government securities, seek to reduce fluctuations in net asset value by hedging against a decline in the value of U.S. government securities owned by the FUND or an increase in the price of such securities which the FUND plans to purchase, although it is not the general practice to do so. Significant option writing opportunities generally exist only with respect to longer term U.S. government securities. Options on U.S. government securities and futures and related options are not considered U.S. government securities; accordingly, they have a different set of risks and features. These practices and related risks are described below. U.S. government securities are considered among the most creditworthy of fixed-income investments. Because of this added safety, the yields available from U.S. government securities are generally lower than the yields available from corporate debt securities. The values of U.S. government securities (like those of fixed-income securities generally) will change as interest rates fluctuate. During periods of falling U.S. interest rates, the values of outstanding long term U.S. government securities generally rise. Conversely, during periods of rising interest rates, the values of such securities generally decline. The magnitude of these fluctuations will generally be greater for securities with longer maturities and the FUND expects that its portfolio of U.S. government securities will be weighted towards the longer maturities at least to the extent that it has written call options thereon. Although changes in the value of U.S. government securities will not affect investment income from those securities, they will affect the FUND's net asset value. The FUND may invest up to 35% of its assets in higher- yielding (and, therefore, higher risk), lower rated bonds and other debt securities and securities with debt-like characteristics, including U.S. corporate fixed-income securities, convertible securities and preferred stocks and unrated corporate fixed-income securities. Lower quality debt securities, commonly referred to as "junk bonds," are considered speculative and involve greater risk of default or price changes due to changes in the issuer's creditworthiness than higher quality debt securities. See "Risk Factors-Lower Quality Debt Securities" below for a discussion of certain risks. -3- Convertible securities are bonds, debentures, notes, preferred stock or other securities which may be converted or exchanged by the holder into shares of the underlying common stock at a stated exchange ratio. A convertible security may also be subject to redemption by the issuer but only after a date and under certain circumstances (including a specified price) established on issue. Adjustable rate preferred stocks are preferred stocks which adjust their dividend rates quarterly based on specified relationships to certain indexes of U.S. Treasury Securities. The FUND may continue to hold securities obtained as a result of the conversion of convertible securities held by the FUND when OFFITBANK believes retaining such securities is consistent with the FUND's investment objective. Differing yields on fixed-income securities of the same maturity are a function of several factors, including the relative financial strength of the issuers. Higher yields are generally available from securities in the lower categories of recognized rating agencies, i.e., Ba or lower by Moody's or BB or lower by Standard & Poor's. The FUND may invest in any security which is rated by Moody's or by Standard & Poor's, or in any unrated security which OFFITBANK determines is of suitable quality. Securities in the rating categories below Baa as determined by Moody's and BBB as determined by Standard & Poor's are considered to be of poor standing and predominantly speculative. The rating services descriptions of these rating categories, including the speculative characteristics of the lower categories, are set forth in Appendix A in the FUND's Prospectus. Securities ratings are based largely on the issuer's historical financial information and the rating agencies' investment analysis at the time of rating. Consequently, the rating assigned to any particular security is not necessarily a reflection of the issuer's current financial condition, which may be better or worse than the rating would indicate. Although OFFITBANK will consider security ratings when making investment decisions in the high yield market, it will perform its own investment analysis and will not rely principally on the ratings assigned by the rating services. OFFITBANK's analysis generally may include, among other things, consideration of the issuer's experience and managerial strength, changing financial condition, borrowing requirements or debt maturity schedules, and its responsiveness to changes in business conditions and interest rates. It also considers relative values based on anticipated cash flow, interest or dividend coverage, asset coverage and earnings prospects. The FUND may invest up to 20% of its assets in international securities consisting of debt obligations and other fixed-income securities, in each case denominated in non-U.S. currencies or composite currencies, including: debt obligations issued or guaranteed by foreign national, provincial, state, municipal or other governments with taxing authority or by their agencies or instrumentalities; debt obligations of supranational entities (described below); debt obligations of the U.S. Government issued in non-dollar securities; and debt obligations and other fixed-income securities of foreign and U.S. corporate issuers (non-dollar denominated). When investing in international securities, the FUND is not limited to purchasing debt securities rated at the time of purchase by Moody's or Standard & Poor's. However, the FUND is limited to the extent that it may not invest more than 35% of its assets in lower quality debt securities. In making international securities investments, OFFITBANK may consider, among other things, the relative growth and inflation rates of different countries. OFFITBANK may also consider expected changes in foreign currency exchange rates, including the prospects for central bank intervention, in determining the anticipated returns of securities denominated in foreign currencies. OFFITBANK may further evaluate, among other things, foreign yield curves and regulatory and political factors, including the fiscal and monetary policies of such countries. The FUND may invest in any country where OFFITBANK sees potential for high income. It presently expects to invest primarily in non-dollar denominated securities of issuers in the industrialized Western European countries; in Canada, Japan, Australia and New Zealand; and in Latin America. The FUND may invest up to 10% of its assets in the debt securities of issuers in emerging market countries. The FUND may invest, without limitation, in unrated debt securities issued by foreign governments, their agencies and instrumentalities, where the foreign government, its agency or instrumentality is rated less than Baa by Moody's or less than BBB by Standard & Poor's, provided, however, that OFFITBANK has -4- determined through its own credit analysis that the credit characteristics of any such unrated security are equivalent to those of a security rated at least Baa by Moody's or BBB by Standard & Poor's. To the extent that OFFITBANK has not made any such determination, such unrated debt securities will be deemed to have the rating assigned by Moody's or Standard & Poor's to the governmental entity. To the extent that such securities are deemed to be rated less than Baa by Moody's or less than BBB by Standard & Poor's, investment in such securities will be subject to the overall 35% limitation on investment in lower quality debt securities. The obligations of foreign governmental entities, including supranational issuers, have various kinds of government support. Obligations of foreign governmental entities include obligations issued or guaranteed by national, provincial, state or other governments with taxing power or by their agencies. These obligations may or may not be supported by the full faith and credit of a foreign government. Supranational entities include international organizations designated or supported by governmental entities to promote economic reconstruction or development and international banking institutions and related government agencies. Examples include the International Bank for Reconstruction and Development (the World Bank), the European Steel and Coal Community, the Asian Development Bank and the Inter-American Development Bank. The governmental agencies, or "stockholders," usually make initial capital contributions to the supranational entity and in many cases are committed to making additional capital contributions if the supranational entity is unable to repay its borrowings. Each supranational entity's lending activities are limited to a percentage of its total capital (including "callable capital" contributed by members at the entity's call), reserves and net income. The FUND does not have a policy of concentrating investments in supranational entities. Risk Factors Lower Quality Debt Securities. The lower quality debt securities that may comprise up to 35% of the FUND's investments generally produce a higher current yield than do debt securities of higher quality. However, these debt securities are considered speculative because they involve greater price volatility and risk than do higher quality debt securities and yields on these debt securities will tend to fluctuate over time. Although the market value of all debt securities varies as a result of changes in prevailing interest rates (e.g., when interest rates rise, the market value of debt securities can be expected to decline), values of lower quality debt securities tend to react differently than the values of higher quality debt securities. The prices of lower quality debt securities are less sensitive to changes in interest rates than higher quality debt securities. Conversely, lower quality debt securities also involve a greater risk of default by the issuer in the payment of principal and income and are more sensitive to economic downturns and recessions than higher quality debt securities. The financial stress resulting from an economic downturn could have a greater negative effect on the ability of issuers of lower quality debt securities to service their principal and interest payments, to meet projected business goals and to obtain additional financing than on more creditworthy issuers. In the event of an issuer's default in payment of principal or interest on such securities, or any other debt securities in the FUND's portfolio, the net asset value of the FUND will be negatively affected. Moreover, as the market for lower quality debt securities is a relatively new one, a severe economic downturn might increase the number of defaults, thereby adversely affecting the value of all outstanding lower quality debt securities and disrupting the market for such securities. Debt securities purchased by the FUND as part of an initial underwriting present an additional risk due to their lack of market history. These risks are exacerbated with respect to debt securities rated Caa by Moody's or CCC by Standard & Poor's. Unrated debt securities generally carry the same risks as do lower rated debt securities. Lower quality debt securities are typically traded among a smaller number of broker-dealers rather than in a broad secondary market. Purchasers of lower quality debt securities tend to be institutions, rather than individuals, a factor that further limits the secondary market. To the extent that no established retail secondary market exists, many lower quality debt securities may not be as liquid as Treasury and investment grade bonds. The ability of the FUND to sell lower quality debt securities will be adversely affected to the extent that such -5- securities are thinly traded or illiquid. Moreover, the ability of the FUND to value lower quality debt securities becomes more difficult, and judgment plays a greater role in valuation, as there is less reliable, objective data available with respect to such securities that are thinly traded or illiquid. Unrated debt securities are not necessarily of lower quality than rated debt securities, but they may not be attractive to as many buyers. Because investors may perceive that there are greater risks associated with the lower quality debt securities of the type in which the FUND may invest, the yields and prices of such securities may tend to fluctuate more than those for lower quality debt securities. Changes in perception of issuers' creditworthiness tend to occur more frequently and in a more pronounced manner in the lower quality segments of the debt securities market than do changes in higher quality segments of the debt securities market, resulting in greater yield and price volatility. The speculative characteristics of lower rated debt securities are set forth in Appendix A in the FUND's Prospectus. OFFITBANK believes that the risks of investing in such high yielding, debt securities may be minimized through careful analysis of prospective issuers. Although the opinion of ratings services such as Moody's and Standard & Poor's is considered in selecting portfolio securities, they evaluate the safety of the principal and the interest payments of the security, not their market value risk. Additionally, credit rating agencies may experience slight delays in updating ratings to reflect current events. OFFITBANK relies, primarily, on its own credit analysis (see above). This may suggest, however, that the achievement of the FUND's investment objective is more dependent on OFFITBANK's proprietary credit analysis, than is otherwise the case for a fund that invests exclusively in higher quality debt securities. Once the rating of a portfolio security or the quality determination ascribed by OFFITBANK to an unrated debt security has been downgraded, OFFITBANK will consider all circumstances deemed relevant in determining whether to continue to hold the security, but in no event will the FUND retain such securities if it would cause the FUND to have more than 35% of the value of its assets invested in debt securities rated lower than Baa by Moody's or BBB or Standard & Poor's, or if unrated, are judged by OFFITBANK to be of comparable quality. Foreign Investments. Foreign investments involve certain risks that are not present in domestic securities. Because the FUND intends to purchase securities denominated in foreign currencies, a change in the value of any such currency against the U.S. dollar will result in a corresponding change in the U.S. dollar value of the FUND's assets and the FUND's income available for distribution. In addition, although a portion of the FUND's investment income may be received or realized in such currencies, the Internal Revenue Code of 1986 (the "Code") requires that the FUND compute and distribute its income in U.S. dollars. Therefore, if the exchange rate for any such currency declines after the FUND's income has been earned and translated into a U.S. dollar equivalent, but before payment of the foreign currency denominated gain, the FUND could be required to liquidate portfolio securities to make such distributions. Similarly, if an exchange rate depreciates between the time the FUND incurs expenses in U.S. dollars and the time such expenses are paid, the amount of such currency required to be converted into U.S. dollars in order to pay such expenses in U.S. dollars will be greater than the equivalent amount in any such currency of such expenses at the time they were incurred. Under the Code, changes in an exchange rate which occur between the time the FUND accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time the FUND actually collects such receivables or pays such liabilities will result in foreign exchange gains or losses that increase or decrease distributable net investment income. Similarly, dispositions of certain debt securities (by sale, at maturity or otherwise) at a U.S. dollar amount which is higher or lower than the FUND's original U.S. dollar cost may result in foreign exchange gains or losses, which will increase or decrease distributable net investment income. The values of foreign investments and the investment income derived from them may also be affected unfavorably by changes in currency exchange control regulations. Although the FUND will invest only in securities denominated in foreign currencies that are fully exchangeable into U.S. dollars without legal -6- restriction at the time of investment, there is no assurance that currency controls will not be imposed subsequently. In addition, the values of foreign fixed-income investments will fluctuate in response to changes in U.S. and foreign interest rates. There may be less information publicly available about a foreign issuer than about a U.S. issuer, and foreign issuers are not generally subject to accounting, auditing and financial reporting standards and practices comparable to those in the United States. The securities of some foreign issuers are less liquid and at times more volatile than securities of comparable U.S. issuers. Foreign brokerage commissions, custodial expenses and other fees are also generally higher than for securities traded in the United States. In addition, with respect to certain foreign countries, there is a possibility of expropriation of assets, confiscatory taxation, political or financial instability and diplomatic developments which could adversely affect the value of investments in those countries. OFFITBANK does not expect to invest the FUND's assets in countries where it believes such events are likely to occur. Income received by the FUND from sources within foreign countries may be reduced by withholding and other taxes imposed by such countries. Tax conventions between certain countries and the United States may reduce or eliminate such taxes. OFFITBANK will attempt to minimize such taxes by timing of transactions and other strategies, but there is no assurance that such efforts will be successful. Any such taxes paid by the FUND will reduce its net income available for distribution to shareholders. Investors should recognize that investing in debt obligations and other fixed-income securities of issuers in emerging countries involves certain special considerations and risk factors, including those set forth below, which are not typically associated with investing in debt obligations and other fixed-income securities of U.S. issuers. Trading volume in emerging country securities markets is substantially less than that in the United States. Further, securities of some emerging country issuers are less liquid and more volatile than securities of comparable U.S. issuers. Commissions for trading on emerging country stock exchanges are generally higher than commissions for trading on U.S. exchanges, although the FUND will endeavor to achieve the most favorable net results on its portfolio transactions and may, in certain instances, be able to purchase its portfolio investments on other stock exchanges where commissions are negotiable. Issuers in emerging countries are not generally subject to uniform accounting, auditing and financial reporting standards, practices and disclosure requirements comparable to those applicable to U.S. issuers. Consequently, there may be less publicly available information about an emerging country issuer than about a U.S. issuer. Further, there is generally less government supervision and regulation of foreign stock exchanges, brokers and listed issuers than in the United States. The FUND may invest in unlisted emerging country debt obligations and other fixed-income securities, including investments in new and early stage issuers, which may involve a high degree of business and financial risk that can result in substantial losses. Because of the absence of any trading market for these investments, the FUND may take longer to liquidate these positions than would be the case for publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized on these sales could be less than those originally paid by the FUND. Further, issuers whose securities are not publicly traded may not be subject to public disclosure and other investor protection requirements applicable to publicly traded securities. 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 upon international trade and, accordingly, have been and may continue to be adversely affected by trade barriers, exchange controls, managed adjustments in relative currency values -7- 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. With respect to any emerging country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, government regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or the value of the FUND's investments in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside of the United States. Mortgage-Related Securities. The FUND may invest in mortgage-related securities. The mortgage pass-through market is marked by high liquidity and credit quality. The primary risk that exists for mortgage pass-through securities is interest rate risk. Changes in market yields will affect the value of these securities as the price of fixed-income securities generally increases when interest rates decline and decreases when interest rates rise. Prices of longer term securities generally increase or decrease more sharply than those of shorter term securities in response to interest rate changes. In addition, prepayment of principal on mortgage pass-through securities may make it difficult to lock in interest rates for a fixed period of time. To the extent that mortgage securities are purchased at prices that differ from par, these prepayments (which are received at par) may make up a significant portion of the pass-through total return. Generally, mortgage securities yield more than Treasury securities of the same average life. Asset-Backed Securities. The FUND may invest in asset-backed securities. In general, asset-backed securities in which the FUND may invest are issued as debt securities by special purpose corporations. These securities represent an undivided ownership interest in a pool of installment sales contracts and installment loans collateralized by, among other things, credit card receivables and automobiles. The FUND will invest in, to the extent available, (i) loan pass-through certificates or participations representing an undivided ownership interest in pools of installment sales contracts and installment loans (the "Participations") and (ii) debt obligations issued by special purpose corporations which hold subordinated equity interests in such installment sales contracts and installment loans. The FUND anticipates that a substantial portion of the asset backed securities in which it invests will consist of the debt obligations of such special purpose corporations. Asset-backed securities, in general, are of a shorter maturity (usually five years) than most conventional mortgage-backed securities and historically have been less likely to experience substantial prepayments. Furthermore, the effect of prepayments on securities that have shorter maturities, such as asset-backed securities, is much smaller than the effect of prepayments on securities having longer maturities, such as mortgage-backed securities. The yield characteristics of asset-backed securities differ from more traditional debt securities in that interest and principal payments are paid more frequently, usually monthly, and principal may be prepaid at any time. As a result, if the FUND purchases an asset-backed security at a discount, similar to conventional mortgage-backed securities, a prepayment rate that is faster than expected will increase yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of reducing yield to maturity. Conversely, if the FUND purchases an asset-backed security at a premium, faster than expected prepayments will reduce, while slower than expected prepayments will increase, yield to maturity. Prepayments may result from a number of factors, including trade-ins and liquidations due to default, as well as the receipt of proceeds from physical damage, credit, life and disability insurance policies. The rate of prepayments on asset-backed securities may also be influenced by a variety of economic and social factors, including general measures of consumer confidence; accordingly, from time to time, substantial amounts of prepayments may be available for reinvestment by the FUND and will be subject to the prevailing interest rates at the time of prepayment. Asset-backed securities often contain elements of credit support to lessen the effect of the potential failure by obligors to make timely payments on underlying assets. Credit support falls into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by an obligor on the -8- underlying asset. Liquidity protection ensures that the pass through of payments due on the installment sales contracts and installment loans which comprise the underlying pool occurs in a timely fashion. Protection against losses resulting from ultimate default enhances the likelihood of ultimate payment of the obligations on at least a portion of the assets in the pool. Such protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties; through various means of structuring the transaction, or through a combination of such approaches. The FUND will not pay any additional fees for such credit support. However, the existence of credit support may increase the market price of the security. Description of Certain Mortgage-Related Securities GNMA Certificates Government National Mortgage Association. The Government National Mortgage Association is a wholly-owned corporate instrumentality of the United States within the U.S. Department of Housing and Urban Development. GNMA's principal programs involve its guarantees of privately issued securities backed by pools of mortgages. Nature of GNMA Certificates. GNMA Certificates are mortgage-backed securities. The Certificates evidence part ownership of a pool of mortgage loans. The Certificates which the FUND purchases are of the modified pass-through type. Modified pass-through Certificates entitle the holder to receive all interest and principal payments owed on the mortgage pool, net of fees paid to the GNMA Certificate issuer and GNMA, regardless of whether or not the mortgagor actually makes the payment. GNMA Certificates are backed by mortgages and, unlike most bonds, their principal amount is paid back by the borrower over the length of the loan rather than in a lump sum at maturity. Principal payments received by the FUND will be reinvested in additional GNMA Certificates or in other permissible investments. GNMA Guarantee. The National Housing Act authorizes GNMA to guarantee the timely payment of principal of and interest on securities backed by a pool of mortgages insured by the Federal Housing Administration ("FHA") or the Farmers Home Administration or guaranteed by the Veterans Administration ("VA"). The GNMA guarantee is backed by the full faith and credit of the United States. GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. Life of GNMA Certificates. The average life of a GNMA Certificate is likely to be substantially less than the original maturity of the mortgage pools underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures will result in the return of a portion of principal invested before the maturity of the mortgages in the pool. As prepayment rates of individual mortgage pools will vary widely, it is not possible to predict accurately the average life of a particular issue of GNMA Certificates. However, statistics published by the FHA are normally used as an indicator of the expected average life of GNMA Certificates. These statistics indicate that the average life of single-family dwelling mortgages with 25-30 year maturities (the type of mortgages backing the vast majority of GNMA Certificates) is approximately twelve years. For this reason, it is customary for pricing purposes to consider GNMA Certificates as 30-year mortgage-backed securities which prepay fully in the twelfth year. Yield Characteristics of GNMA Certificates. The coupon rate of interest of GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or FHA-insured mortgages underlying the Certificates, but only by the amount of the fees paid to GNMA and the GNMA Certificate issuer. For the most common type of mortgage pool, containing single-family dwelling mortgages, GNMA receives an annual fee of 0.06 of one percent of the outstanding principal for providing its guarantee, and the GNMA Certificate issuer is paid an -9- annual servicing fee of 0.44 of one percent for assembling the mortgage pool and for passing through monthly payments of interest and principal to Certificate holders. The coupon rate by itself, however, does not indicate the yield which will be earned on the Certificates for the following reasons: 1. Certificates are usually issued at a premium or discount, rather than at par. 2. After issuance, Certificates usually trade in the secondary market at a premium or discount. 3. Interest is paid monthly rather than semi-annually as is the case for traditional bonds. Monthly compounding has the effect of raising the effective yield earned on GNMA Certificates. 4. The actual yield of each GNMA Certificate is influenced by the prepayment experience of the mortgage pool underlying the Certificate. If mortgagors prepay their mortgages, the principal returned to Certificate holders may be reinvested at higher or lower rates. In quoting yields for GNMA Certificates, the customary practice is to assume that the Certificates will have a twelve-year life. Compared on this basis, GNMA Certificates have historically yielded roughly 1/4 of one percent more than high grade corporate bonds and 1/2 of one percent more than U.S. Government and U.S. Government agency bonds. As the life of individual pools may vary widely, however, the actual yield earned on any issue of GNMA Certificates may differ significantly from the yield estimated on the assumption of a twelve-year life. Market for GNMA Certificates. Since the inception of the GNMA mortgage-backed securities program in 1970, the amount of GNMA Certificates outstanding has grown rapidly. The size of the market and the active participation in the secondary market by securities dealers and many types of investors make GNMA Certificates highly liquid instruments. Quotes for GNMA Certificates are readily available from securities dealers and depend on, among other things, the level of market rates, the Certificate's coupon rate and the prepayment experience of the pool of mortgages backing each Certificate. FNMA Securities The Federal National Mortgage Association ("FNMA") was established in 1938 to create a secondary market in mortgages insured by the FHA. FNMA issues guaranteed mortgage pass-through certificates ("FNMA Certificates"). FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate represents a pro rata share of all principal and interest payments made and owed on the underlying pool. FNMA guarantees timely payment of interest and principal on FNMA Certificates. The FNMA guarantee is not backed by the full faith and credit of the United States. FHLMC Securities The Federal Home Loan Mortgage Corporation ("FHLMC") was created in 1970 to promote development of a nationwide secondary market in conventional residential mortgages. The FHLMC issues two types of mortgage pass-through securities ("FHLMC Certificates"): mortgage participation certificates ("PCs") and guaranteed mortgage certificates ("GMCs"). PCs resemble GNMA Certificates in that each PC represents a pro rata share of all interest and principal payments made and owned on the underlying pool. The FHLMC guarantees timely monthly payment of interest on PCs and the ultimate payment of principal. GMCs also represent a pro rata interest in a pool of mortgages. However, these instruments pay interest semiannually and -10- return principal once a year in guaranteed minimum payments. The expected average life of these securities is approximately ten years. The FHLMC guarantee is not backed by the full faith and credit of the United States. Futures contracts The FUND may enter into contracts for the purchase or sale for future delivery of fixed-income securities or foreign currencies which otherwise meet the FUND's investment policies, to the extent permitted by the Commodity Futures Trading Commission (the "CFTC"). U.S. futures contracts have been designed by exchanges which have been designated "contract markets" by the CFTC, and must be executed through a futures commission merchant, or brokerage firm, which is a member of the relevant contract market. Futures contracts trade on a number of contract markets, and, through their clearing corporations, the exchanges guarantee performance of the contracts as between the clearing members of the exchange. The FUND will enter into futures contracts which are based on debt securities that are backed by the full faith and credit of the U.S. Government, such as Treasury Notes, Government National Mortgage Association modified pass-through mortgage-backed securities and three-month U.S. Treasury Bills. The FUND may also enter into futures contracts which are based on non-U.S. Government bonds. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific, interest rate-sensitive financial instrument (debt security) at a specified price, date, time and place. A foreign currency futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specified foreign currency at a specified price, date, time and place. The FUND may not enter into futures transactions if the sum of the amount of initial margin deposits on its existing futures contracts and premiums paid for unexpired options would exceed 5% of the fair market value of the FUND'S total assets, after taking into account unrealized profits and unrealized losses on commodity contracts it has entered into. The FUND will not use leverage when it enters into long futures or options contracts and for each such long position the FUND will deposit cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, having a value equal to the underlying commodity value of the contract as collateral with its custodian in a segregated account. No consideration is paid or received by the FUND upon entering into a futures contract. Upon entering into a futures contract, the FUND will be required to deposit in a segregated account with its custodian an amount of cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, equal to approximately 5% of the contract amount (this amount is subject to change by the exchange on which the contract is traded and brokers may charge a higher amount). This amount is known as "initial margin" and 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 broker will have access to amounts in the margin account if the FUND fails to meet its contractual obligations. Subsequent payments, known as "variation margin," to and from the broker, will be made daily as the price of the currency or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract more or less valuable, a process known as "marking-to-market." At any time prior to the expiration of a futures contract, the FUND may elect to close the position by taking an opposite position, which will operate to terminate the FUND's existing position in the contract. There are several risks in connection with the use of futures contracts. Successful use of futures contracts is subject to the ability of FUND management to predict correctly movements in the price of the securities or currencies underlying the particular transaction. These predictions and, thus, the use of futures contracts involve skills and techniques that are different from those involved in the management of portfolio securities. Positions in futures contracts and options on futures contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange). No secondary market for such -11- contracts exists. Although the FUND intends to enter into futures contracts only if there is an active market for such contracts, there is no assurance that an active market will exist for the contracts at any particular time. Most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting the FUND to substantial losses. In such event, and in the event of adverse price movements, the FUND would be required to make daily cash payments of variation margin. Options on Futures Contracts The FUND may purchase and write put and call options on interest rate and foreign currency contracts that are traded on a U.S. exchange or board of trade or a foreign exchange, to the extent permitted by the CFTC, and may enter into closing transactions with respect to such options to terminate existing positions. There is no guarantee that such closing transactions can be effected. An option on an interest rate or foreign currency contract, as contrasted with the direct investment in such a contract, gives the purchaser the right, in return for the premium paid, to assume a position in an interest rate or foreign currency contract at a specified exercise price at any time prior to the expiration date of the option. Options on interest rate futures contracts currently available include those with respect to U.S. Treasury Bonds, U.S. Treasury Notes, U.S. Treasury Bills and Eurodollars. Options on foreign currency futures currently available include those with respect to British Pounds, Swiss Francs, Japanese Yen, Canadian Dollars and Australian Dollars. Upon exercise of an option, the delivery of the futures position by the writer of the option to the holder of the option will be accompanied by delivery of the accumulated balance in the writer's futures margin account, which represents the amount by which the market price of the futures contracts exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The potential loss related to the purchase of an option on futures contracts is limited to the premium paid for the option (plus transaction costs). Because the value of the option is fixed at the point of sale, there are no daily cash payments to reflect changes in the value of the underlying contract; however, the value of the option does change daily and that change would be reflected in the net asset value of the FUND. Options on Foreign Currencies The FUND may purchase and write options on foreign currencies to increase its gross income in a manner similar to that in which futures contracts on foreign currencies, or forward contracts, will be utilized. The FUND intends to write covered call options on foreign currencies. A call option written on a foreign currency by the FUND is "covered" if the FUND owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its Custodian or by a designated sub-custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the FUND has a call on the same foreign currency and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price or the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the FUND in cash, U.S. Government Securities and other high grade liquid debt securities in a segregated account with its Custodian or with a designated sub-custodian. As a writer of a covered put option, the FUND incurs an obligation to buy the security underlying the option from the purchaser of the put, at the option's exercise price at any time during the option period, at the purchaser's election (certain listed and over-the-counter put options written by the FUND will be exercisable by the purchaser only on a specific date). A put is "covered" if, at all times, the FUND maintains, in a segregated account maintained on its behalf at the FUND's custodian, cash, U.S. Government securities or other high grade obligations in an amount equal to at least the exercise price of the option, at all times during the option period. Similarly, a short put position could be covered by the FUND -12- by its purchase of a put option on the same security (currency) as the underlying security of the written option, where the exercise price of the purchased option is equal to or more than the exercise price of the put written or less than the exercise price of the put written if the marked to market difference is maintained by the FUND in cash, U.S. Government securities or other high grade debt obligations which the FUND holds in a segregated account maintained at its custodian. Forward Currency Contracts The FUND may engage in currency exchange transactions as a portfolio management technique. The FUND will conduct its currency exchange transactions either on a spot (i.e., cash) basis at the rate prevailing in the currency exchange market, or through entering into forward contracts to purchase or sell currency. A forward currency contract involves an obligation to purchase or sell a specific currency at a future date, which may be any fixed number of days from the date of the contract agreed upon by the parties, at a price set at the time of the contract. If a devaluation is generally anticipated, the FUND may not be able to contract to sell the currency at a price above the devaluation level it anticipates. The FUND will not enter into a currency transaction if, as a result, it will fail to qualify as a regulated investment company under the Code for any given year. Options on Portfolio Securities The FUND may write only covered call option contracts. Currently, the principal exchanges on which such options may be written are the Chicago Board Option Exchange and the American, Philadelphia, and Pacific Stock Exchanges. In addition, the FUND may purchase and sell options in the over-the-counter market ("OTC Options"). A call option gives the purchaser of the option the right to buy the underlying security from the writer at the exercise price at any time prior to the expiration of the contract, regardless of the market price of the security during the option period. The premium paid to the writer is the consideration for undertaking the obligations under the option contract. The writer forgoes the opportunity to profit from an increase in the market price of the underlying security above the exercise price so long as the option remains open and covered, except insofar as the premium represents such a profit. The staff of the Securities and Exchange Commission (the "SEC") has taken the position that purchased over-the-counter options and the assets used as cover for written over-the-counter options are illiquid securities. The FUND will write OTC Options only with primary U.S. Government Securities dealers recognized by the Board of Governors of the Federal Reserve System or member banks of the Federal Reserve System ("primary dealers"). The FUND may also write, to the extent available, OTC Options with non-primary dealers, such as foreign dealers; however, unlike OTC Options written with primary dealers, any OTC Options written with such non-primary dealers and the assets used as cover for such options will be treated as illiquid securities. In connection with these special arrangements, the FUND intends to establish standards for the creditworthiness of the primary and non-primary dealers with which it may enter into OTC Option contracts and those standards, as modified from time to time, will be implemented and monitored by the Manager. Under these special arrangements, the FUND will enter into contracts with primary and non-primary dealers which provide that the FUND has the absolute right to repurchase an option it writes at any time at a repurchase price which represents the fair market value, as determined in good faith through negotiation between the parties, but which in no event will exceed a price determined pursuant to a formula contained in the contract. Although the specific details of the formula may vary between contracts with different primary and non-primary dealers, the formula will generally be based on a multiple of the premium received by the FUND for writing the option, plus the amount, if any, by which the option is "in-the-money." The formula will also include a factor to account for the difference between the price of the security and the strike price of the option if the option is written "out-of-the-money." Under such circumstances, and with respect to OTC Options written with primary dealers only, the FUND will treat as illiquid that amount of the "cover" assets equal to the amount by which the formula price for the repurchase of the option is greater than the amount by which the market value of the security subject to the option exceeds the exercise price of the option (the amount by which -13- the option is "in-the-money"). Although each agreement will provide that the FUND's repurchase price shall be determined in good faith (and that it shall not exceed the maximum determined pursuant to the formula) the formula price will not necessarily reflect the market value of the option written, therefore, the FUND might pay more to repurchase the OTC Option contract than the FUND would pay to close out a similar exchange traded option. In determining the FUND's net asset value, the current market value of any option written by the FUND is subtracted from net asset value. If the current market value of the option exceeds the premium received by the FUND, the excess represents an unrealized loss, and, conversely, if the premium exceeds the current market value of the option, such excess would be unrealized gain. Risks of Options on Futures Contracts, Forward Contracts and Options on Foreign Currencies Unlike transactions entered into by the FUND in certain futures contracts, certain other futures contracts, options on foreign currencies and forward contracts are not traded on contract markets regulated by the CFTC and forward currency contracts are not regulated by the Commission. Instead, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board options Exchange, subject to regulation by the Commission. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the Commission, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the Options Clearing Corporation (the "OCC"), thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the FUND to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, future contracts, options on futures contracts, forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. -14- Pursuant to the sub-advisory agreement, OFFITBANK, where permitted by law, will purchase and sell foreign exchange in the interbank dealer market for a fee on behalf of the FUND, subject to certain procedures and reporting requirements adopted by the Board of Trustees. Repurchase Agreements The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans as defined by the Investment Company Act of 1940, as amended (the "1940 Act"), collateralized by the underlying securities. The return on the collateral may be more or less than that from the repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day so that the value of the collateral is at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, OFFITBANK will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. Lending of Portfolio Securities In order to generate additional income, the FUND may lend its portfolio securities in an amount up to 33-1/3% of total FUND assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities. No lending may be made to any companies affiliated with ^ VCM or OFFITBANK. The borrower at all times during the loan must maintain with the FUND cash or cash equivalent collateral or provide to the FUND an irrevocable letter of credit equal in value at all times to at least 100% of the value of the securities loaned. During the time portfolio securities are on loan, the borrower pays the FUND any dividends or interest paid on such securities, and the FUND may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. Loans are subject to termination at the option of the FUND or the borrower at any time. The FUND may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the income earned on the cash to the borrower or placing broker. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by the FUND over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid -15- securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 10% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering." Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The SEC has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. The FUND, a non-diversified management investment company, has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND -16- may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having securities, other than U.S. government securities, of as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within any one industry (except that this restriction does not apply to U.S. government securities); or (d) more than 5% of net assets would be invested in warrants or rights. (Included within that amount, but not to exceed 2% of the value of the FUND's net assets, may be warrants which are not listed on the New York or American Stock Exchanges.) 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 20% of the market value of its total assets). This does not preclude the FUND from obtaining such short-term credit as may be necessary for the clearance of purchases and sales of its portfolio securities. The FUND will not purchase additional securities while the amount of any borrowings is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities except (i) through repurchase agreements, (ii) through loan participations, and (iii) through the lending of its portfolio securities as described in "Lending of Portfolio Securities" in the Prospectus and in this Statement. 5. The FUND may not invest more than 5% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities, except as they may be acquired as part of a merger, consolidation or acquisition of assets. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. 7. The FUND may not buy any securities or other property on margin (except for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 8. The FUND may not invest in companies for the purpose of exercising control or management. 9. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 10. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM or OFFITBANK, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 11. The FUND may not purchase or sell real property (including limited partnership interests, but excluding readily marketable interests in real estate investment trusts or readily marketable securities of companies which invest in real estate). 12. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs or leases. -17- 13. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Manager subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreement between VCM and OFFITBANK. In selecting such brokers or dealers, OFFITBANK will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to OFFITBANK for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to OFFITBANK. Such allocation shall be in such amounts as VCM or OFFITBANK shall determine and OFFITBANK shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to OFFITBANK in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of OFFITBANK's other clients may be useful to OFFITBANK in carrying out its obligations to the FUND. The receipt of such research may not reduce OFFITBANK's normal independent research activities. OFFITBANK is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and OFFITBANK or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from portfolio transactions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the advisory fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between ^ VCM and OFFITBANK does not provide for any reduction in the advisory fees as a result of profits resulting from portfolio transactions effected through OFFITBANK or an affiliated brokerage firm. The Trustees have adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid the Distributor or to OFFITBANK or an affiliated -18- broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. It may happen that the same security will be held by other clients of VCM or of OFFITBANK. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. For the fiscal years ended April 30, 1994 and 1995, the FUND's rate of portfolio turnover was approximately 212% and 84%, respectively. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The FUND may invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees. Portfolio securities of the FUND which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, normally 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. -19- Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 p.m. (New York time) will be confirmed at the previous offering price computed as of the close of trading on the options exchanges (normally 4:15 p.m., New York time), provided the order is received by the FUND's Transfer Agent prior to 4:15 p.m. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 p.m. will be confirmed at the next computed offering price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 1 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the one year period ended April 30, 1995 and for the life of the FUND (April 16, 1993 to April 30, 1995) was 5.34% and 4.51% respectively. -20- The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect until December 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: ^ YIELD = 2[(a-b+1)6-1] cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that wer entitled to receive dividends. d = the maximum offering price per share on the last day of the period. Under this formula, interest earned on debt obligations for purposes of "all above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses; however, the FUND will disclose the pro rata share of the account opening fee. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing -21- performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. For the 30-day period ended April 30, 1995, the FUND's yield was 5.55%. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to Federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses, including foreign currency gains and loss) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its "investment company taxable income" (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated -22- hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. At April 30, 1995, the FUND had a net capital loss carryover of $401,749 which is avaiable through April 30, 2003 to offset future capital gains. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Code Section 1256, will generally be treated as ordinary income or loss. Generally, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contract have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a -23- consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss (except for Section 1256 forward foreign currency contracts, which are subject to Section 988 Rules). The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service has held in several private rulings that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. Treasury regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss, or any net foreign currency loss incurred after October 31 as if they had been incurred in the succeeding year. In addition to satisfying the requirements described above, the fund must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, options (call or put) with respect to a security are treated as issued by the issuer of the security and not by the issuer of the option. However, with regard to forward currency contracts, there does not appear to be any formal or informal authority which identifies the issuer of such instrument. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the -24- excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for Federal income tax purposes, but they will not qualify for the 70% dividends-received deduction for corporations. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consists of the stock or securities of foreign corporations (which is not likely), the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid his pro rata share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against Federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. -25- Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. Federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign -26- shareholder would generally be exempt from U.S. Federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. Federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. Federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. Federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. Federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, -27- Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. -28- Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and member, Board of Trustees, University of Pittsburgh; Medical Director, Unviersity of Pittsburgh Medical Center-Downtown, member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. -29- Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh,PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. -30- (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process. The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. -31- Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. -32- The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the period from April 16, 1993 (commencement of operations) to April 30, 1993 and for the fiscal year ended April 30, 1994, the FUND's investment management fees paid to the prior manager were $486 and $192,383, respectively, all of which were deferred by the prior manager. For the fiscal year ended April 30, 1995, the FUND's investment management fee paid to the prior manager was $235,737, of which $181,185 was voluntarily waived by the prior manager. THE SUB-ADVISORY AGREEMENT OFFITBANK furnishes investment advisory services to the FUND pursuant to a Sub-Advisory Agreement between VCM and OFFITBANK. Pursuant to the Sub-Advisory Agreement, OFFITBANK supervises the investment and reinvestment of the cash, securities or other properties comprising the FUND's portfolio, subject at all times to the direction of VCM and the policies and control of the Trust's Board of Trustees. OFFITBANK gives the FUND the benefit of its best judgment, efforts and facilities in rendering its services as Sub-Adviser. In carrying out its obligations, OFFITBANK: (a) uses the same skill and care in providing such service as it uses in providing services to fiduciary accounts for which it has investment responsibilities; (b) obtains and evaluates pertinent information about significant developments and economics, statistical and financial data, domestic, foreign or otherwise, whether affecting the economy generally or the FUND's portfolio and whether concerning the individual issuers whose securities are included in the FUND's portfolio or the activities in which the issuers engage, or with respect to securities which it considers desirable for inclusion in the FUND's portfolio; (c) determines which issuers and securities shall be represented in the FUND's portfolio and regularly reports thereon to the Trust's Board of Trustees; (d) formulates and implements continuing programs for the purchases and sales of the securities of such issuers and regularly reports thereon to the Trust's Board of Trustees; (e) is authorized to give instructions to the custodian and/or sub-custodian of the FUND appointed by the Trust's Board of Trustees, as to deliveries of securities, transfers of currencies and payments of cash for the account of the FUND, in relation to the matters contemplated by this Agreement; and (f) takes, on behalf of the FUND, all actions which appear to the Trust and VCM necessary to carry into effect such purchase and sale programs and supervisory functions as aforesaid, including the placing of orders for the purchase and sale of securities for the FUND and the prompt reporting to VCM of such purchases and sales. OFFITBANK is responsible for decisions to buy and sell securities for the FUND's portfolio, broker-dealer selection, and negotiation of brokerage commission rates. OFFITBANK's primary consideration in effecting a security transaction will be execution at the most favorable price. In selecting a broker-dealer to execute each particular transaction, OFFITBANK will take the following into consideration: the best net price available, the reliability, integrity and financial condition of the broker-dealer; the size of and difficulty in executing the order; and the value of the expected contribution of the broker-dealer to the investment performance of the FUND on a continuing basis. Accordingly, the price to the FUND in any transaction may be less favorable than that available from another broker-dealer if the difference is reasonably justified by other aspects of the portfolio execution services offered. Subject to such policies as the Board of Trustees may determine, OFFITBANK shall not be deemed to have acted unlawfully or to have breached any duty created under the Sub-Advisory Agreement or otherwise solely by reason of its having caused the FUND to pay a broker or dealer for effecting a portfolio investment transaction in excess of the amount of commission another -33- broker or dealer would have charged for effecting that transaction, if OFFITBANK determines in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such broker or dealer, viewed in terms of either that particular transaction or OFFITBANK's overall responsibilities with respect to the FUND and to its other clients as to which it exercises investment discretion. Subject to such policies as the Board of Trustees may determine, OFFITBANK will purchase and sell foreign currency and futures contracts and other securities for the FUND. OFFITBANK is further authorized to allocate the orders placed by it on behalf of the FUND to any affiliated broker-dealer of the FUND or to such brokers and dealers who also provide research or statistical material, or other services to the FUND, VCM or OFFITBANK. Such allocation is in such amounts and proportions as OFFITBANK shall determine and OFFITBANK will report on said allocations regularly to the Board of Trustees of the Trust indicating the brokers to whom such allocations have been made and the basis therefor. Any investment program undertaken by OFFITBANK pursuant to the Sub-Advisory Agreement, as well as any other activities undertaken by OFFITBANK on behalf of the FUND pursuant thereto, is at all times subject to any directives of the Board of Trustees of the Trust. VCM provides OFFITBANK with written notice of all such directives, so long as the Sub-Advisory Agreement remains in effect. Pursuant to the Sub-Advisory Agreement, OFFITBANK maintains, at its expense and without cost to VCM or the FUND, a trading function in order to carry out its obligations to place orders for the purchase and sale of portfolio securities for the FUND. Pursuant to the Sub-Advisory Agreement, upon request of VCM and with the approval of the Trust's Board of Trustees, OFFITBANK may perform services on behalf of the FUND which are not required by the Sub-Advisory Agreement. Such services will be performed on behalf of the FUND and OFFITBANK's cost in rendering such services may be billed monthly to VCM, subject to examination by VCM's independent accountants. Payment or assumption by OFFITBANK of any FUND expense that OFFITBANK is not required to pay or assume under the Sub-Advisory Agreement shall not relieve VCM or OFFITBANK of any of their obligations to the FUND or obligate OFFITBANK to pay or assume any similar FUND expense on any subsequent occasions. Pursuant to the Sub-Advisory Agreement, for the services to be rendered and the facilities furnished hereunder, VCM pays OFFITBANK a monthly fee at the annual rate of .30% of the FUND's first $25 million of average daily net assets; plus .25% of the FUND's average daily net assets in excess of $25 million but less than $50 million; plus .20% of the FUND's average daily net assets in excess of $50 million. The prior manager has advised the FUND that the fees paid to OFFITBANK were $195 for the period ended April 30, 1993, $45,697 for the fiscal year ended April 30, 1994 and $27,254 for the fiscal year ended April 30, 1995. Compensation under the Sub-Advisory Agreement is calculated and accrued daily and the amounts of the daily accruals are paid monthly. The compensation paid to OFFITBANK will not be reduced by the amount of brokerage commissions received by OFFITBANK or its affiliated broker-dealer pursuant to Section 17(e)(2) of the 1940 Act. Pursuant to the Sub-Advisory Agreement, OFFITBANK agrees that it will not render advisory or sub-advisory services to any other similar publicly offered no-load or low-load open-end investment company registered with the SEC while the Sub-Advisory Agreement is in effect. The Sub-Advisory Agreement was approved by the then Trustees on March 24, 1995. The Sub-Advisory Agreement will remain in force and effect for an initial term of two years, and shall remain in effect thereafter from year to year, provided that such continuance is specifically approved at least annually: (a) (i) by the Trust's Board of Trustees or (ii) by the vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a)(42) of the 1940 Act), and (b) by the affirmative vote of a majority of the Trustees who are not parties to the Sub-Advisory Agreement or interested persons of a party to the Sub-Advisory Agreement (other than as a Trustee of the Trust), by votes cast in person at a meeting specifically called for such purpose. -34- The Sub-Advisory Agreement may be terminated at any time, without the payment of any penalty, by vote of the Trust's Board of Trustees or by vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a) (42) of the 1940 Act), or by VCM or OFFITBANK on sixty (60) days' written notice to the other party. The Sub-Advisory Agreement automatically terminates: (a) in the event of its assignment, the term "assignment" having the meaning defined in Section 2(a)(4) of the 1940 Act, or (b) in the event that the Investment Advisory Contract between the FUND and VCM shall terminate. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the FUND accrued payments under the Plan amouting to $78,579. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust." Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by -35- the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. FINANCIAL STATEMENTS Audited financial statements of the FUND for the fiscal year ended April 30, 1995, are attached hereto. -36- Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Short-Term Bond Fund for the fiscal year ending April 30, 1995. As the head of the team responsible for the portfolio management of your Fund, it is my pleasure to report on the Fund's progress during the fiscal year. Thanks to an unprecedented series of interest rate hikes by Alan Greenspan and the Federal Reserve, 1994 was a very difficult year for bond markets. Even so, your Blanchard Short-Term Bond Fund was able to produce a positive total return of 1.02% for the 12 months ending 12/31/94, and 5.34% for the 12 months ending 4/30/95. This was no small feat, as only a total of 192 bond funds were able to claim a positive total return in 1994. That's out of a total universe of 2,959 bond funds tracked by Morningstar, Inc. Of course, past performance is no guarantee of future results. As with any fixed income investment, the Fund's yield, investment return and principal value will vary so that shares, when redeemed, may be worth more or less than their original pur- chase price. As you might surmise, we are very pleased with the result, as the overriding objective of your Fund is to provide a solid level of steady income while making every effort to preserve capital. We were able to produce such a The following information was reprint as a line graph. - -------------------------------------------------------------------------------- The Value of a $10,000 Investment in the Blanchard Short-Term Bond Fund inception 4/16/93 through 4/30/95 as compared to the Merrill Lynch Short-Term Treasuries Index for the same period ------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Short-Term Bond Fund* ------------------------------------- 1 year 5.34% since inception 4.51% ------------------------------------- FYE 4/30/93 FYE 4/30/94 FYE 4/30/95 STBF 0.15% 3.72% 5.34% MERRILL LYNCH 0.30% 1.62% 5.77% M.L. Corp & Govt 0.20% 1.34% 6.12% $10,000.00 $10,015 $10,388 $10,942 $10,000.00 $10,030 $10,192 $10,781 $10,000.00 $10,020 $10,154 $10,776 Blanchard Merrill Lynch Merrill Lynch Short-Term Short-Term Short-Term Govt. Bond Fund Treasuries Index(D) Corporate Index^ *The average annual and total returns quoted above and the chart shown above do not reflect the deduction of management fees and some expenses which have been waived. If reflected, the returns, which also reflect reinvestment of distributions, would be lower. The total return includes changes in principal value. Average annual return is total return annualized and compounded. Past performance is no guarantee of future results. (D)Source: Merrill Lynch Short-Term Treasury Index is an unmanaged index of U.S. Treasury bonds with maturities from 1 to 2.999 years. Unlike the BSTBF, Treasury bonds are guaranteed by the U.S. government. ^Source: Merrill Lynch Short-Term Government Corporate Index is an unmanaged index of corporate and government issues with maturities from 1 to 4.99 years. This chart is for comparative purposes only and is not intended to reflect future performance of the BSTBF, the indices, or Treasury bonds. - -------------------------------------------------------------------------------- (over, please) result by investing the portfolio in high-quality bonds, and keeping its average portfolio maturity very short. We avoided the mistake of some short-term bond funds, which may have been imprudent in their exposure to riskier alternative markets, including even emerging market debt. So far, 1995 has been a far more positive environment for bond investors, allowing us to add a satisfactory level of capital gains to our income. Over the two years since its inception, your Fund has continued to provide a relatively stable share price and solid monthly income. As shown in the chart at the beginning of this letter, its performance compares favorably with the Merrill Lynch Short-Term Treasuries Index, an unmanaged index of U.S. Treasury Bonds which cannot be invested in directly. We have also compared performance to the Merrill Lynch Short-Term Government Corporate Index. We believe that, going forward, this index more closely approximates the portfolio make-up of your Blanchard Short-Term Bond Fund. Naturally, past performance is no guarantee of future results. Looking Ahead Following the strong bond rally early in 1995, we have become somewhat more cautious on a short-term basis. As a result, the Fund's conservative portfolio mandate should serve you well. Longer-term, however, we believe that interest rates have now settled in a lower range than they have been in several years. While inflation may move somewhat higher, we don't believe it will increase to any significant degree. In essence, we are currently enjoying what a number of analysts have come to call a "soft landing." In simple terms, this means that while economic activity will most likely regain some momentum, helped along by the recent decline in interest rates and by the decline in the value of the dollar, any such expansion should not accelerate to a worrisome level in the foreseeable future. We thank you for your continued support and look forward to serving you in the months and years ahead. Sincerely, JB:ml Jack Burks Managing Director of OFFITBANK Portfolio Managers of the Blanchard Short-Term Bond Fund Distributed by Sheffield Investments, Inc. (1551) 06ARSL0695 BLANCHARD SHORT-TERM BOND FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Principal Value --------- ----- U.S. FIXED INCOME (70.2%) CORPORATE BONDS (4.1%) Consumer Related (2.2%) RJR Nabisco Inc. 8.30%, 4/15/99 ...................... $ 500,000 $ 509,828 ----------- Industrial Related (1.9%) PDV America Inc. 7.25%, 8/01/98 ...................... 500,000 455,841 ----------- TOTAL CORPORATE BONDS ............. 965,669 ----------- U.S. GOVERNMENT AND AGENCY ISSUES (66.1%) Federal National Mortgage Association 8.20%, 8/10/98 .......... 1,000,000 1,005,763 Government National Mortgage Association II 10%, 6/20/16 209,064 221,673 Resolution Trust Corp. 6%, 1/15/04 ... 250,000 249,688 U.S. Treasury Notes 6.88%, 10/31/96 ..................... 4,500,000 4,523,904 U.S. Treasury Notes 7.50%, 2/29/96 ... 2,500,000 2,523,438 U.S. Treasury Notes 7.50%, 1/31/96 ... 2,000,000 2,016,874 U.S. Treasury Notes 5.50%, 4/30/96 ... 5,000,000 4,959,375 ----------- TOTAL U.S. GOVERNMENT AND AGENCY ISSUES 15,500,715 TOTAL U.S. FIXED INCOME (IDENTIFIED COST $16,521,040) ..................... 16,466,384 ----------- U.S. HIGH YIELD SECURITIES (24.5%) U.S. CORPORATE BONDS (24.5%) Airlines (0.7%) U.S. Air Inc. Series D 9.8%, 1/15/00 ....................... 200,000 173,250 ----------- Basic Materials (2.1%) Owens Illinois Inc. 10.25%, 4/01/99 .. 500,000 511,250 Consumer Related (3.0%) MacAndrews & Forbes Group Inc. 12.25%, 7/01/96 ..................... 200,000 201,500 Revlon Consumer Products Corp. 9.50%, 6/01/99 ...................... 500,000 491,250 ----------- 692,750 ----------- (Right Column) Principal Value --------- ----- Energy & Oil Related (3.4%) Texas New Mexico Power Co. 9.25%, 9/15/00 ...................... $400,000 $ 399,584 Triton Energy Corp. 0%, 11/01/97 ..... 500,000 398,750 ----------- 798,334 ----------- Financial Services (8.0%) Great American Holding Corp. 11%, 8/15/98 ........................ 500,000 501,875 Navistar Financial Group Corp. 8.88%, 11/15/98 ..................... 500,000 492,500 Presidential Life Corp. 9.50%, 12/15/00 ..................... 400,000 386,000 Reliance Group Holdings Inc. 9.0%, 11/15/00 ...................... 500,000 476,875 ----------- 1,857,250 ----------- Industrial Related (5.1%) Armco, Inc. 9.38%, 11/01/00 .......... 350,000 331,625 Sequa Corp. 8.75%, 12/15/01 .......... 350,000 329,437 Unisys Corp. 10.63%, 10/01/99 ........ 500,000 527,197 ----------- 1,188,259 ----------- Medical Services (1.5%) Healthsouth Rehabilitation Corp. 9.50%, 4/01/01 ...................... 350,000 357,875 ----------- Telecommunications (0.7%) SCI Television Inc. 7.50%, 6/30/98 ... 168,800 167,112 ----------- TOTAL U.S. HIGH YIELD SECURITIES (IDENTIFIED COST $5,880,640) ............... 5,746,080 ----------- SHORT-TERM SECURITIES (3.2%) Associates Corp. of N.A. 5.80%, 5/01/95 ...................... 740,000 740,000 ----------- TOTAL SHORT-TERM SECURITIES (IDENTIFIED COST $740,000) .................. 740,000 ----------- TOTAL INVESTMENTS (97.9%)(a) (IDENTIFIED COST $23,141,680) .................... 22,952,464 CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (2.1%) .... 492,043 ----------- NET ASSETS (100%) ................ $23,444,507 ----------- - --------------- (a) The aggregate cost for federal income tax purposes is $23,141,680; the gross unrealized appreciation is $12,801; and the gross unrealized depreciation is $202,017; resulting in net unrealized depreciation of $189,216. See notes to financial statements. 3 BLANCHARD SHORT-TERM BOND FUND (Left Column) STATEMENT OF ASSETS AND LIABILITIES APRIL 30, 1995 Assets: Investments in securities, at value (Identified Cost $23,141,680) (note 1) .......................... $22,952,464 Cash .................................. 47,520 Receivables for: Interest ............................ 543,053 Shares of beneficial interest sold .. 501 Deferred organizational expenses (note 1) ............................ 48,680 ----------- Total assets ...................... 23,592,218 ----------- Liabilities: Payables for: Shares of beneficial interest repurchased ....................... 106,165 Dividends ............................. 7,015 Accrued expenses and other liabilities ......................... 34,531 Total liabilities ................. 147,711 ----------- Net assets ........................ $23,444,507 =========== Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 7,985,358 shares outstanding) ........................ $24,355,402 Accumulated overdistributed investment income - net ............. (58,696) Accumulated realized loss - net ....... (662,983) Unrealized net depreciation of investments ......................... (189,216) ----------- Net assets ........................ $23,444,507 =========== Net asset value per share ......... $2.94 ===== (Right Column) STATEMENT OF OPERATIONS For the Year Ended April 30, 1995 Investment income: Interest .............................. $1,934,317 ---------- Expenses Investment management fee (note 2) .............. $235,737 Accounting fees ............. 96,176 Plan of distribution (note 3) .................. 78,579 Transfer agent fees ......... 75,999 Trustees' fees, retirement plan curtailment and other expenses (note 5) ... 36,894 Custodian fees .............. 36,080 Professional fees ........... 34,282 Registration fees ........... 27,500 Shareholder reports and notices ................... 24,950 Organizational expenses ..... 15,429 Other ....................... 4,474 -------- Total expenses ............ 666,100 Less: Fund expenses voluntarily waived by Manager and Distributor (note 2) .... (234,663) -------- Net expenses .......................... 431,437 ---------- Investment income - net ............... 1,502,880 ---------- Realized and unrealized gain (loss) - net (note 1): Realized gain (loss) on: Investments - net (541,619) Forward currency contracts and foreign exchange transactions - net (30,645) (572,264) -------- Change in unrealized appreciation or depreciation on investments - net ..... 443,090 ---------- Net realized and unrealized losses ...... (129,174) ---------- Net increase in net assets resulting from operations ............. $1,373,706 ========== See notes to financial statements. 4 BLANCHARD SHORT-TERM BOND FUND STATEMENT OF CHANGES IN NET ASSETS
For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income - net .......................................................... $ 1,502,880 $ 1,441,173 Realized loss - net .............................................................. (572,264) (214,464) Change in unrealized appreciation or depreciation - net .......................... 443,090 (631,753) ----------- ----------- Net increase in net assets resulting from operations ............................. 1,373,706 594,956 ----------- ----------- Dividends and distributions to shareholders from: Investment income - net .......................................................... (1,502,880) (1,440,603) Dividends in excess of investment income - net ................................... (18,912) -- Realized gains - net ............................................................. - (102,660) ----------- ----------- ..................................................................................... (1,521,792) (1,543,263) ----------- ----------- Transactions in shares of beneficial interest - net increase (decrease) (note 6) ..... (18,788,567) 41,131,587 ----------- ----------- Net increase (decrease) in net assets ............................................ (18,936,653) 40,183,280 Net assets: Beginning of year ................................................................ 42,381,160 2,197,880 ----------- ----------- End of year (including accumulated overdistributed investment income - net of $58,696 and $189,258, respectively) ............................ $23,444,507 $42,381,160 =========== ===========
See notes to financial statements. 5 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard Short-Term Bond Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940, as amended (the "Act"). The Fund had no operations before April 16, 1993 other than the sale of shares of beneficial interest to Sheffield Management Company (the "Manager") and OFFITBANK (the "Portfolio Adviser"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sales are made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. The ability of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a particular country, industry or region. The Fund invests a portion of its assets in high yield securities, which may be subject to a greater degree of credit risk, greater market fluctuations and risks of loss of income and principal, and may be more sensitive to economic conditions than lower yielding, higher rated fixed income securities. B. Accounting for Investments and Investment Income-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rate at the end of the period, and (2) purchases, sales, income and expenses are translated at rates of exchange prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from changes in market prices of equity investments during the period. However, in accordance with the requirements of the Internal Revenue Code, the Fund isolates the effect of changes in foreign exchange rates from the fluctuations arising from changes in market prices of foreign debt obligations sold, and such foreign exchange losses, which amounted to $24,650, are included in ordinary income for federal 6 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 income tax purposes and have been reclassified from realized gain (loss) on investments to realized gain (loss) on forward currency contracts and foreign exchange transactions - net in the Statement of Operations. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, the level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future foreign exchange rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. The Fund generally enters into a forward currency contract as a hedge against foreign exchange rate fluctuations upon the purchase or sale of a security denominated in a foreign currency. The Fund maintains, as collateral, U.S. Government or other highly liquid debt obligations in an amount equal to or greater than its net obligation for forward currency contracts. Risks may arise as a result of the potential inability of the counterparties to meet the terms of their contracts. D. Federal Income Tax Status-It is Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. E. Dividends and Distribution to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in capital. F. Organizational Expenses-The Fund's Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to $77,143. The Fund reimbursed the Manager for these expenses and has deferred and is amortizing such expenses on the straight-line method over five years from the date of commencement of the Fund's operations. G. Other-Certain expenses for the Blanchard Funds are allocated among the Funds based upon their relative average net assets. 7 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of .75% of the Fund's average daily net assets. For the year ended April 30, 1995, the Manager and Distributor voluntarily waived the advisory and distribution fee, which amounted to $181,185 and $5,944, respectively, and absorbed $47,534 of other expenses of the Fund. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses, are subject to the expense limitation imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed such limitation. Certain officers and/or Trustees of the Fund are officers/directors of the Manager. The Manager has sub-advisory agreements with the Portfolio Adviser. The Manager has advised the Fund that fees paid to the Portfolio Adviser were $27,254 for the year ended April 30, 1995. Although not required to do so pursuant to the Management Agreement and Distribution Plan in effect between the Fund and its Manager and Sheffield Investments, Inc. (the "Distributor"), respectively, the Manager and the Distributor voluntarily agreed that they will defer all or a portion of fees payable to them and absorb a portion of other expenses until further notice. Such deferred fees and expense absorptions are subject to later reimbursement. The Manager and the Distributor have conditioned their right to receive a portion of any earned but deferred fees and to receive reimbursement for absorbed expenses (measured on a rolling two-year period, starting from the date the portion of the fee is deferred and/or the expenses are absorbed) upon the Fund reaching and maintaining the following specified levels of net assets for 30 continuous days (excluding assets exchanged into the Fund from other funds in the Blanchard Group of Funds) provided that such reimbursement would not cause the Fund's expenses in such a year to exceed 1.75% of average daily net assets. Conditional Portion of Specified Level of Earned but Deferred Fund's Net Assets Fees to be Received $50 Million 25% 60 Million 25% 70 Million 25% 80 Million 25% --- 100% === Subject to this agreement, $360,855 which was deferred in fiscal 1994 was permanently waived by the Manager and Distributor in fiscal 1995. 8 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, the Distributor, an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the Plan, the Fund may pay distribution fees not to exceed .25% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after April 16, 1993, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $486,173. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Short-Term Bond Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. 9 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $33,808,339 and $24,658,325, respectively, including purchases and sales of U.S. Government obligations of $32,814,578 and $18,848,241, respectively. The Manager has advised the Fund that, for the year ended April 30, 1995, it incurred costs, which were reimbursed by the Fund, amounting to $36,438 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees' fees, retirement plan curtailment and other fees in the Statement of Operations for the year ended April 30, 1995 was $5,230. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $24,679 was recorded to reflect the previously unrecognized prior service costs of the independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $29,909 of accrued pension expense. NOTE 6 - Shares of Beneficial Interest: For the For the Year Ended Year Ended April 30, 1995 April 30, 1994 -------------- -------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold ..................... 7,207,260 $21,020,411 28,775,937 $86,052,474 Reinvestment of dividends and distributions ...... 460,620 1,341,339 456,142 1,364,050 ----------- ----------- ----------- ----------- 7,667,880 22,361,750 29,232,079 87,416,524 Repurchased .............. (14,143,317) (41,150,317) (15,504,618) (46,284,937) ----------- ------------ ----------- ----------- Net increase (decrease) .. (6,475,437) $(18,788,567) 13,727,461 $41,131,587 =========== ============ =========== =========== NOTE 7 - Federal Income Taxes: Capital and foreign currency losses incurred after October 31 ("post-October losses") within the taxable year are deemed to arise on the first business day of the Fund's next taxable year. The Fund incurred and will elect to defer net capital and foreign currency losses of approximately $247,000 and $7,000, respectively during fiscal 1995. 10 BLANCHARD SHORT-TERM BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to post-October loss deferrals and non-deductible expenses. The Fund had permanent book/tax differences primarily attributable to foreign currency losses. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, paid-in-capital was charged $187,618, accumulated realized loss-net was credited $38,144 and accumulated overdistributed investment income-net was credited $149,474. At April 30, 1995 the Fund had a net capital carryover of $401,749 which is available through April 30, 2003 to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders. NOTE 8 - Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding: For the Period April 16, 1993 For the Year Ended (commencement April 30, of operations) to ------------------------- April 30, 1995 1994 1993 ---- ---- ---- Per Share Operating Performance: Net asset value, beginning of period ......................... $2.93 $3.00 $3.00 ----- ----- ----- Income from investment operations: Net investment income ...................................... .15 .17 .00(3) Net gains or losses on securities (both realized and unrealized) .............................................. .00(3) (.06) .00(3) ----- ----- ----- Net income from investment operations .................... .15 .11 .00(3) ----- ----- ----- Less dividends and distributions: Dividends from net investment income ....................... (.14) (.17) .00(3) Dividends in excess of net investment income................ (.00)(3) -- -- Distributions from realized gains - net .................... .00 (.01) .00(3) ----- ----- ----- Change in net asset value ................................ .01 (.07) .00(3) ----- ----- ----- Net asset value, end of period ............................... $2.94 $2.93 $3.00 ===== ===== ===== Total return ................................................. 5.34% 3.72% .15%(4) Ratios/Supplemental Data: Net assets end of period ($ Million) ....................... $23 $42 $2 Ratio of expenses to average net assets .................... 1.38%(2) .63%(2) 3.03%(1) Ratio of net investment income to average net assets ....... 4.80%(2) 5.64%(2) 3.89%(1) Portfolio turnover ........................................... 84% 212% 36% - ------------- (1) Annualized. (2) The ratios of expenses to average net assets and net investment income to average net assets would have been 2.13% and 4.05%, respectively, for the year ended April 30, 1995 and 2.05% and 4.22%, respectively, for the year ended April 30, 1994, if a portion of the Fund's expenses had not been voluntarily deferred and absorbed by the Manager and Distributor. (3) Less than one cent per share. (4) Not annualized.
11 BLANCHARD SHORT-TERM BOND FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Short-Term Bond Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Short-Term Bond Fund (the "Fund") at April30, 1995, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended and the financial highlights for each of the two years in the period then ended and for the period April 16, 1993 (commencement of operations) through April30, 1993, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 12 (Left Column) Portfolio Adviser OFFITBANK Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Short-Term Bond Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) Blanchard Short-Term Bond Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD FLEXIBLE TAX-FREE BOND FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Flexible Tax-Free Bond Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History............................................. 2 Investment Objective and Policies........................................... 2 Securities in Which the FUND May Invest..................................... 3 Investment Restrictions..................................................... 9 Portfolio Transactions..................................................... 9 Computation of Net Asset Value.............................................. 10 Performance Information..................................................... 11 Additional Purchase and Redemption Information.............................. 13 Tax Matters................................................................. 13 The Management of the FUND.................................................. 18 Management Services......................................................... 23 The Advisory Agreement...................................................... 23 Administrative Services..................................................... 25 Distribution Plan.......................................................... 25 Description of the FUND..................................................... 26 Shareholder Reports......................................................... 26 Appendix A - Description of Bond Ratings.................................... A-1 Appendix B - Financial Statements........................................... B-1 Manager Virtus Capital Management, Inc. Portfolio Adviser United States Trust Company of New York Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. The FUND is a "no-load" fund which seeks to provide a high level of current interest income exempt from Federal income tax consistent with the preservation of principal. The FUND invests primarily in obligations of varying maturities issued by or on behalf of states, territories and possessions of the United States and the District of Columbia and their political subdivisions, agencies, authorities and instrumentalities, the interest from which, in the opinion of bond counsel for the issuer, is exempt from Federal income tax ("Municipal Obligations"). There is no assurance that the FUND will achieve its investment objective. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with, the sections in the FUND's Prospectus entitled "Investment Objective and Policies," "Securities in Which the Fund May Invest" and "Other Investment Information." The FUND's investment objective is to provide a high level of current interest income exempt from Federal income tax consistent with the preservation of principal. The FUND will invest at least 65% of its assets in Municipal Obligations, except when maintaining a temporary defensive position. The FUND invests in Municipal Obligations which are determined by U.S. Trust to present minimal credit risks. As a matter of fundamental policy, except during temporary defensive periods, the FUND will maintain at least 80% of its assets in tax-exempt obligations. (This policy may not be changed without the vote of the holders of a majority of the FUND's outstanding shares.) However, from time to time on a temporary defensive basis due to market conditions, the FUND may hold uninvested cash reserves or invest in taxable obligations in such proportions as, in the opinion of U.S. Trust, prevailing market or economic conditions may warrant. Uninvested cash reserves will not earn income. Should the FUND invest in taxable obligations, it would purchase: (i) obligations of the U.S. Treasury; (ii) obligations of agencies and instrumentalities of the U.S. Government; (iii) money market instruments, such as certificates of deposit, commercial paper, and bankers' acceptances; (iv) repurchase agreements collateralized by U.S. Government obligations or other money market instruments; (v) municipal bond index futures and interest rate futures contracts; or (vi) securities issued by other investment companies that invest in high quality, short-term securities. Interest income from certain short-term holdings may be taxable to shareholders as ordinary income. In seeking to achieve its investment objective, the FUND may invest in "private activity bonds" (see "Municipal Obligations" below), the interest on which is treated as a specific tax preference item under the Federal alternative minimum tax. Investments in such securities, however, will not exceed, under normal market conditions, 20% of the FUND's total assets when added together with any taxable investments held by the FUND. The Municipal Obligations purchased by the FUND will consist of: (1) municipal bonds rated "A" or better by Moody's Investors Service, Inc. ("Moody's") or by Standard & Poor's Corporation ("S&P") or, in certain instances, municipal bonds with lower ratings if they are deemed by U.S. Trust to be comparable to A-rated issues; (2) municipal notes rated "MIG-2" or better ("VMIG-2" or better in the case of variable rate notes) by Moody's or "SP-2" or better by S&P; and (3) municipal commercial paper rated "Prime-2" or better by Moody's or "A-2" or better by S&P. If not rated, securities purchased by the FUND will be of comparable quality to the above ratings as determined by U.S. Trust under the supervision of the FUND's Board of Trustees. A discussion of Moody's and S&P's rating categories is contained in Appendix A. -2- Although the FUND does not presently intend to do so on a regular basis, it may invest more than 25% of its assets in Municipal Obligations the interest on which is paid solely from revenues of similar projects, if such investment is deemed necessary or appropriate by U.S. Trust. To the extent that the FUND's assets are concentrated in Municipal Obligations payable from revenues on similar projects, the FUND will be subject to the peculiar risks presented by such projects to a greater extent than it would be if the FUND's assets were not so concentrated. SECURITIES IN WHICH THE FUND MAY INVEST Municipal Obligations. The two principal classifications of Municipal Obligations which may be held by the FUND are "general obligation" securities and "revenue" securities. General obligation securities are secured by the issuer's pledge of its full faith, credit, and taxing power for the payment of principal and interest. Revenue securities are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise tax or other specific revenue source such as the user of the facility being financed. Private activity bonds held by the FUND are in most cases revenue securities and are not payable from the unrestricted revenues of the issuer. Consequently, the credit quality of private activity revenue bonds is usually directly related to the credit standing of the corporate user of the facility involved. The FUND's portfolio may also include "moral obligation" securities, which are normally issued by special-purpose public authorities. If the issuer of moral obligation securities is unable to meet its debt service obligations from current revenues, it may draw on a reserve fund the restoration of which is a moral commitment, but not a legal obligation of the state or municipality which created the issuer. There is no limitation on the amount of moral obligation securities that may be held by the FUND. The FUND may also purchase custodial receipts evidencing the right to receive either the principal amount or the periodic interest payments ("stripped") or both with respect to specific underlying Municipal Obligations. In general, such "stripped" Municipal Obligations are offered at a substantial discount in relation to the principal and/or interest payments which the holders of the receipt will receive. To the extent that such discount does not produce a yield to maturity for the investor that exceeds the original tax-exempt yield on the underlying Municipal Obligation, such yield will be exempt from Federal income tax for such investor to the same extent as interest on the underlying Municipal Obligation. The FUNDs intend to purchase "stripped" Municipal Obligations only when the yield thereon will be, as described above, exempt from Federal income tax to the same extent as interest on the underlying Municipal Obligations. "Stripped" Municipal Obligations are considered illiquid securities subject to the 10% limit described in "Investment Limitations" in the Statement of Additional Information. Futures Contracts. The FUND may purchase and sell municipal bond index and interest rate futures contracts as a hedge against changes in market conditions. A municipal bond index assigns values daily to the municipal bonds included in the index based on the independent assessment of dealer-to-dealer municipal bond brokers. A municipal bond index futures contract represents a firm commitment by which two parties agree to take or make a delivery of an amount equal to a specified dollar amount times the difference between the municipal bond index value on the last trading date of the contract and the price at which the futures contract is originally struck. No physical delivery of the underlying securities in the index is made. The FUND may enter into contracts for the future delivery of fixed-income securities commonly known as interest rate futures contracts. Interest rate futures contracts are similar to the municipal bond index futures contracts except that, instead of a municipal bond index, the "underlying commodity" is represented by various types of fixed-income securities. The FUND will not engage in transactions in futures contracts for speculation, but only as a hedge against changes in market values of securities which it holds or intends to purchase where the transactions are -3- intended to reduce risks inherent in the management of the FUND. The FUND may engage in futures contracts only to the extent permitted by the Commodity Futures Trading Commission ("CFTC") and the Securities and Exchange Commission ("SEC"). When investing in futures contracts, the FUND must satisfy certain asset segregation requirements to ensure that the use of futures is unleveraged. When the FUND takes a long position in a futures contract, it must maintain a segregated account containing cash and/or certain liquid assets equal to the purchase price of the contract, less any margin or deposit. When the FUND takes a short position in a futures contract, the FUND must maintain a segregated account containing cash and/or certain liquid assets equal to the market value of the securities underlying such contract, less any margin or deposit, which must be at least equal to the market price at which the short position was established. Transactions by the FUND in futures contracts may subject the FUND to a number of risks. Successful use of futures by the FUND is subject to the ability of U.S. Trust to anticipate correctly movements in the direction of the market. In addition, there may be an imperfect correlation, or no correlation at all, between movements in the price of the futures contracts and movements in the price of the instruments being hedged. Further, there is no assurance that a liquid market will exist for any particular futures contract at any particular time. Consequently, the FUND may realize a loss on a futures transaction that is not offset by a favorable movement in the price of securities which it holds or intends to purchase, or it may be unable to close a futures position in the event of adverse price movements. Any income from investments in futures contracts will be taxable income of the FUND. Money Market Instruments. Money market instruments that may be purchased by the FUND in accordance with its investment objectives and policies stated above include, among other things, bank obligations, commercial paper and corporate bonds with remaining maturities of 13 months or less. Bank obligations include bankers' acceptances, negotiable certificates of deposit, and non-negotiable time deposits earning a specified return and issued by a U.S. bank which is a member of the Federal Reserve System or insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation, or by a savings and loan association or savings bank which is insured by the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation. Investments in time deposits are limited to no more than 5% of the value of the FUND's total assets at time of purchase. Investments by the FUND in commercial paper will consist of issues that are rated "A-2" or better by S&P or "Prime-2" or better by Moody's. In addition, the FUND may acquire unrated commercial paper that is determined by U.S. Trust at the time of purchase to be of comparable quality to rated instruments that may be acquired by the FUND. Commercial paper may include variable and floating rate instruments. While there may be no active secondary market with respect to a particular instrument purchased by the FUND, the FUND may, from time to time as specified in the instrument, demand payment of the principal of the instrument or may resell the instrument to a third party. The absence of an active secondary market, however, could make it difficult for the FUND to dispose of the instrument if the issuer defaulted on its payment obligation or during periods that the FUND is not entitled to exercise its demand rights, and the FUND could, for this or other reasons, suffer a loss with respect to such instrument. Repurchase Agreements. As stated above, the FUND may agree to purchase portfolio securities subject to the seller's agreement to repurchase them at a mutually agreed upon date and price ("repurchase agreements"). The FUND will enter into repurchase agreements only with financial institutions such as banks or broker/dealers which are deemed to be creditworthy by U.S. Trust under guidelines approved by the FUND's Board of Trustees. The FUND will not enter into repurchase agreements with U.S. Trust or its -4- affiliates. Repurchase agreements maturing in more than seven days will be considered illiquid securities subject to the 10% limit described in "Investment Restrictions." The seller under a repurchase agreement will be required to maintain the value of the obligations subject to the agreement at not less than the repurchase price. Default or bankruptcy of the seller would, however, expose the FUND to possible delay in connection with the disposition of the underlying securities or loss to the extent that proceeds from a sale of the underlying securities were less than the repurchase price under the agreement. Income on the repurchase agreements will be taxable. Investment Company Securities. The FUND may also invest in securities issued by other investment companies that invest in high-quality, short-term securities and that determine their net asset value per share based on the amortized cost or penny-rounding method. In addition to the advisory fees and other expenses the FUND bears directly in connection with its own operations, as a shareholder of another investment company, the FUND would bear its pro rata portion of the other investment company's advisory fees and other expenses. As such, the FUND's shareholders would indirectly bear the expenses of the FUND and the other investment company, some or all of which would be duplicative. Such securities will be acquired by the FUND within the limits prescribed by the Investment Company Act of 1940 (the "1940 Act"). When-Issued and Forward Transactions and Stand-By Commitments. The FUND may purchase eligible securities on a "when-issued" basis and may purchase or sell securities on a "forward commitment" basis. These transactions involve a commitment by the FUND to purchase or sell particular securities with payment and delivery taking place in the future, beyond the normal settlement date, at a stated price and yield. Securities purchased on a "forward commitment" or "when issued" basis are recorded as an asset and are subject to changes in value based upon changes in the general level of interest rates. It is expected that forward commitments and "when-issued" purchases will not exceed 25% of the value of the FUND's total assets absent unusual market conditions, and that the length of such commitments will not exceed 45 days. The FUND does not intend to engage in "when-issued" purchases and forward commitments for speculative purposes, but only in furtherance of its investment objectives. In addition, the FUND may acquire "stand-by commitments" with respect to Municipal Obligations that it holds. Under a "stand-by commitment," a dealer agrees to purchase, at the FUND's option, specified Municipal Obligations at a specified price. The FUND will acquire "stand-by commitments" solely to facilitate portfolio liquidity and does not intend to exercise its rights thereunder for trading purposes. "Stand-by commitments" acquired by the FUND would be valued at zero in determining the FUND's net asset value. Risk Factors: Futures contracts. The FUND may enter into contracts for the purchase or sale for future delivery of municipal bond indices or fixed-income securities which otherwise meet the FUND's investment policies, to the extent permitted by the Commodity Futures Trading Commission (the "CFTC"). U.S. futures contracts have been designed by exchanges which have been designated "contract markets" by the CFTC, and must be executed through a futures commission merchant, or brokerage firm, which is a member of the relevant contract market. Futures contracts trade on a number of contract markets, and, through their clearing corporations, the exchanges guarantee performance of the contracts as between the clearing members of the exchange. A municipal bond index futures contract represents a firm commitment by which two parties agree to take or make a delivery of an amount equal to a specified dollar amount times the difference between the municipal bond index value on the last trading date of the contract and the price at which the futures contract is originally struck. An interest rate futures contract provides for the future sale by one party and the purchase by the other party of a certain amount of a specific, interest rate-sensitive financial instrument (debt security) at a specified price, date, time and place. -5- The FUND will not use leverage when it enters into long futures or options contracts. For each such long position the FUND will deposit cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, having a value equal to the underlying commodity value of the contract as collateral with its custodian in a segregated account. No consideration is paid or received by the FUND upon entering into a futures contract. Upon entering into a futures contract, the FUND will be required to deposit in a segregated account with its custodian an amount of cash or cash equivalents, such as U.S. Government Securities or high grade debt obligations, equal to approximately 5% of the contract amount (this amount is subject to change by the exchange on which the contract is traded and brokers may charge a higher amount). This amount is known as "initial margin" and 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 broker will have access to amounts in the margin account if the FUND fails to meet its contractual obligations. Subsequent payments, known as "variation margin," to and from the broker, will be made daily as the price of the currency or securities underlying the futures contract fluctuates, making the long and short positions in the futures contract more or less valuable, a process known as "marking-to-market." At any time prior to the expiration of a futures contract, the FUND may elect to close the position by taking an opposite position, which will operate to terminate the FUND's existing position in the contract. There are several risks in connection with the use of futures contracts. Successful use of futures contracts is subject to the ability of FUND management to predict correctly movements in the price of the securities or currencies underlying the particular transaction. These predictions and, thus, the use of futures contracts involve skills and techniques that are different from those involved in the management of portfolio securities. Positions in futures contracts may be closed out only on the exchange on which they were entered into (or through a linked exchange). No secondary market for such contracts exists. Although the FUND intends to enter into futures contracts only if there is an active market for such contracts, there is no assurance that an active market will exist for the contracts at any particular time. Most futures exchanges limit the amount of fluctuation permitted in futures contract prices during a single trading day. Once the daily limit has been reached in a particular contract, no trades may be made that day at a price beyond that limit. It is possible that futures contract prices could move to the daily limit for several consecutive trading days with little or no trading, thereby preventing prompt liquidation of futures positions and subjecting the FUND to substantial losses. In such event, and in the event of adverse price movements, the FUND would be required to make daily cash payments of variation margin. Repurchase Agreements. The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans, as defined by the 1940 Act, collateralized by the underlying securities. The return on the collateral may be more or less than that from the repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day so that the value of the collateral is at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, the Portfolio Adviser will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. -6- Lending of Portfolio Securities In order to generate additional income, the FUND may lend its portfolio securities in an amount up to 33-1/3% of total FUND assets to broker-dealers, major banks, or other recognized domestic institutional borrowers of securities. No lending may be made to any companies affiliated with VCM or the Portfolio Adviser. The borrower at all times during the loan must maintain with the FUND cash or cash equivalent collateral or provide to the FUND an irrevocable letter of credit equal in value at all times to at least 100% of the value of the securities loaned. During the time portfolio securities are on loan, the borrower pays the FUND any dividends or interest paid on such securities, and the FUND may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower who has delivered equivalent collateral or a letter of credit. Loans are subject to termination at the option of the FUND or the borrower at any time. The FUND may pay reasonable administrative and custodial fees in connection with a loan and may pay a negotiated portion of the income earned on the cash to the borrower or placing broker. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 10% of the FUND's total assets (taken at market value) would be invested in such securities. The staff of the SEC defines an illiquid security as any security that cannot be disposed of within seven days in the ordinary course of business at approximately the amount at which the company has valued the instrument. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 10% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering." Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The SEC has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional -7- buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. 1. The FUND, a non-diversified management investment company, at the close of each quarter of the FUND's taxable year, has the following restrictions: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having securities, other than U.S. Government securities, of as few as twelve issuers. 2. The FUND will not purchase a security if, as a result: (a) it would own more than 10% of any class or of the outstanding voting securities of any single company; (b) more than 5% of its total assets would be invested in the securities of companies (including predecessors) that have been in continuous operation for less than 3 years; (c) more than 25% of its total assets would be concentrated in companies within any one industry (except that this restriction does not apply to U.S. Government securities); or (d) more than 5% of net assets would be invested in warrants or rights. (Included within that amount, but not to exceed 2% of the value of the FUND's net assets, may be warrants which are not listed on the New York or American Stock Exchanges.) 3. The FUND may borrow money from a bank solely for temporary or emergency purposes (but not in an amount equal to more than 20% of the market value of its total assets). This does not preclude the FUND from obtaining such short-term credit as may be necessary for the clearance of purchases and sales of its portfolio securities. The FUND will not purchase additional securities while the amount of any borrowings is in excess of 5% of the market value of its total assets. 4. The FUND will not make loans of money or securities except (i) through repurchase agreements, (ii) through loan participations, and (iii) through the lending of its portfolio securities as described in the Prospectus and in this Statement of Additional Information. -8- 5. The FUND may not invest more than 10% of its total assets in the securities of other investment companies or purchase more than 3% of any other investment company's voting securities, except as they may be acquired as part of a merger, consolidation or acquisition of assets. 6. The FUND may not pledge, mortgage or hypothecate its assets, except that to secure borrowings permitted by Restriction 3 above, the FUND may pledge securities having a value at the time of pledge not exceeding 10% of the market value of the FUND's total assets. Collateral arrangements with respect to the FUND's permissible futures transactions, including initial and variation margin, are not considered to be a pledge of assets for purposes of this restriction. 7. The FUND may not buy any securities or other property on margin (except for the deposit of initial or variation margin in connection with hedging and risk management transactions and for such short term credits as are necessary for the clearance of transactions) or engage in short sales. 8. The FUND may not invest in companies for the purpose of exercising control or management. 9. The FUND may not underwrite securities issued by others except to the extent that the FUND may be deemed an underwriter when purchasing or selling portfolio securities. 10. The FUND may not purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM or the Portfolio Adviser who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 11. The FUND may not purchase or sell real property (including limited partnership interests, but excluding readily marketable securities of companies which invest in real estate). 12. The FUND may not invest directly in oil, gas, or other mineral exploration or development programs or leases. 13. The FUND may not issue senior securities. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Adviser subject to the supervision of ^ VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreement between VCM and the Portfolio Adviser. In selecting such brokers or dealers, the Portfolio Adviser will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. -9- In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to the Portfolio Adviser for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to the Portfolio Adviser. Such allocation shall be in such amounts as VCM or the Portfolio Adviser shall determine and the Portfolio Adviser shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to the Portfolio Adviser in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of the Portfolio Adviser's other clients may be useful to the Portfolio Adviser in carrying out its obligations to the FUND. The receipt of such research may not reduce the Portfolio Adviser's normal independent research activities. The Portfolio Adviser is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. ("the Distributor"), and the Portfolio Adviser or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from portfolio transactions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the management fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, the Sub-Advisory Agreement between VCM and the Portfolio Adviser does not provide for any reduction in the advisory fees as a result of profits resulting from portfolio transactions effected through the Portfolio Adviser or an affiliated brokerage firm. The Trustees have adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid to the Distributor or to the Portfolio Adviser or an affiliated broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time." The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. It may happen that the same security will be held by other clients of VCM or of the Portfolio Adviser. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. -10- COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. Portfolio securities of the FUND for which market quotations are readily available (other than debt securities maturing in 60 days or less) will be valued at market value. Securities which are traded on the Over-the-Counter market will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 p.m. (New York time) will be confirmed at the previous offering price computed as of the close of trading on the options exchanges (normally 4:15 p.m., New York time), provided the order is received by the FUND's Transfer Agent prior to 4:15 p.m. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 p.m. will be confirmed at the next computed offering price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. -11- Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The Fund's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the one year period ended April 30, 1995 and for the life of the Fund (August 12, 1993 to April 30, 1995) was 10.74% and 5.83%, respectively. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. and Morningstar, Inc., or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect from August, 1993 to ___________ 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per -12- share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: a-b YIELD = 2[(----------+1)6-1] cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. Under this formula, interest earned on debt obligations for purposes of "all" above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses; however, the FUND will disclose the pro rata share of the account opening fee. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. For the 30-day period ended April 30, 1995 the FUND's yield was 4.22%. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder -13- selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussion here and in the Prospectus is not intended as a substitute for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to Federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses, including foreign currency gains and loss) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its "investment company taxable income" (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. In addition to satisfying the Distribution Requirement, a regulated investment company with investment objectives, policies and restrictions similar to the FUND must (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock or securities (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, or securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. At April 30, 1995, the FUND had a net capital loss carryover of $748,924 which is available through April 30, 20003 to offset future capital gains. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. Generally, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (i) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (ii) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified -14- covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (iii) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (i) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contract have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The FUND may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The Internal Revenue Service has held in several private rulings and Treasury Regulations now provide that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, or any net long-term capital loss incurred after October 31 as if they had been incurred in the succeeding year. In addition to satisfying the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, options (call or put) with respect to a security are treated as issued by the issuer of the security and not by the issuer of the option. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will he subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable as ordinary dividends to the extent of the -15- FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for Federal income tax purposes, but they will not qualify for the 70% dividends-received deduction for corporations. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment -16- income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. Federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the Internal Revenue Service for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the -17- FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having been paid. Such a foreign shareholder would generally be exempt from U.S. Federal income tax on gains realized on the sale of shares of the FUND and capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends and any gains realized upon the sale of shares of the FUND will be subject to U.S. Federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. Federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. Federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. Federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. THE MANAGEMENT OF THE FUND: Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; -18- Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. -19- Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh-Downtown; member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. -20- Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. -21- (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process. The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. -22- Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds.
MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. -23- The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the period from August 12, 1993 (commencement of operations) to April 30, 1994 and the fiscal year ended April 30, 1995 the FUND's investment management fees to the prior manager were as $89,180.00 and $127,835, respectively, all which was voluntarily waived. For the same periods, the prior manager paid fees to the Portfolio Adviser of $9,758.00. THE ADVISORY AGREEMENT The Portfolio Adviser furnishes investment advisory services to the FUND pursuant to an Advisory Agreement between VCM and the Portfolio Adviser. Pursuant to the Advisory Agreement, the Portfolio Adviser supervises the investment and reinvestment of the cash, securities or other properties comprising the FUND's portfolio, subject at all times to the direction of VCM and the policies and control of the Trust's Board of Trustees. The Portfolio Adviser gives the FUND the benefit of its best judgment, efforts and facilities in rendering its services as Portfolio Adviser. In carrying out its obligations, the Portfolio Adviser: (a) uses the same skill and care in providing such service as it uses in providing services to fiduciary accounts for which it has investment responsibilities; (b) obtains and evaluates pertinent information about significant developments and economics, statistical and financial data, domestic, foreign or otherwise, whether affecting the economy generally or the FUND's portfolio and whether concerning the individual issuers whose securities are included in the FUND's portfolio or the activities in which the issuers engage, or with respect to securities which it considers desirable for inclusion in the FUND's portfolio; (c) determines which issuers and securities shall be represented in the FUND's portfolio and regularly reports thereon to the Trust's Board of Trustees; (d) formulates and implements continuing programs for the purchases and sales of the securities of such issuers and regularly reports thereon to the Trust's Board of Trustees; (e) is authorized to give instructions to the custodian and/or sub-custodian of the FUND appointed by the Trust's Board of Trustees, as to deliveries of securities, transfers of currencies and payments of cash for the account of the FUND, in relation to the matters contemplated by this Agreement; and (f) takes, on behalf of the FUND, all actions which appear to the Trust and VCM necessary to carry into effect such purchase and sale programs and supervisory functions as aforesaid, including the placing of orders for the purchase and sale of securities for the FUND and the prompt reporting to VCM of such purchases and sales. The Portfolio Adviser is responsible for decisions to buy and sell securities for the FUND's portfolio, broker-dealer selection, and negotiation of brokerage commission rates. The Portfolio Adviser's primary consideration in effecting a security transaction will be execution at the most favorable price. In selecting a broker-dealer to execute each particular transaction, the Portfolio Adviser will take the following into consideration: the best net price available, the reliability, integrity and financial condition of the broker-dealer; the size of and difficulty in executing the order; and the value of the expected contribution of the broker-dealer to the investment performance of the FUND on a continuing basis. Accordingly, the price to the FUND in any transaction may be less favorable than that available from another broker-dealer if the difference is reasonably justified by other aspects of the portfolio execution services offered. Subject to such policies as the Board of Trustees may determine, the Portfolio Adviser shall not be deemed to have acted unlawfully or to have breached any duty created under the Advisory Agreement or otherwise solely by reason of its having caused the FUND to pay a broker or dealer for effecting a portfolio investment transaction in excess of the amount of commission another broker or dealer would have charged for effecting that transaction, if the Portfolio Adviser determines -24- in good faith that such amount of commission was reasonable in relation to the value of the brokerage and research services provided by such broker or dealer, viewed in terms of either that particular transaction or the Portfolio Adviser's overall responsibilities with respect to the FUND and to its other clients as to which it exercises investment discretion. Subject to such policies as the Board of Trustees may determine, the Portfolio Adviser will purchase and sell foreign currency and futures contracts and other securities for the FUND. The Portfolio Adviser is further authorized to allocate the orders placed by it on behalf of the FUND to any affiliated broker-dealer of the FUND or to such brokers and dealers who also provide research or statistical material, or other services to the FUND, VCM or the Portfolio Adviser. Such allocation is in such amounts and proportions as the Portfolio Adviser shall determine and the Portfolio Adviser will report on said allocations regularly to the Board of Trustees of the Trust indicating the brokers to whom such allocations have been made and the basis therefor. Any investment program undertaken by the Portfolio Adviser pursuant to the Advisory Agreement, as well as any other activities undertaken by the Portfolio Adviser on behalf of the FUND pursuant thereto, is at all times subject to any directives of the Board of Trustees of the Trust. VCM provides the Portfolio Adviser with written notice of all such directives, so long as the Advisory Agreement remains in effect. Pursuant to the Advisory Agreement, the Portfolio Adviser maintains, at its expense and without cost to VCM or the FUND, a trading function in order to carry out its obligations to place orders for the purchase and sale of portfolio securities for the FUND. Pursuant to the Advisory Agreement, upon request of VCM and with the approval of the Trust's Board of Trustees, the Portfolio Adviser may perform services on behalf of the FUND which are not required by the Advisory Agreement. Such services will be performed on behalf of the FUND and the Portfolio Adviser's cost in rendering such services may be billed monthly to VCM subject to examination by VCM's independent accountants. Payment or assumption by the Portfolio Adviser of any FUND expense that the Portfolio Adviser is not required to pay or assume under the Advisory Agreement shall not relieve VCM or the Portfolio Adviser of any of their obligations to the FUND or obligate the Portfolio Adviser to pay or assume any similar FUND expense on any subsequent occasions. Pursuant to the Advisory Agreement, for the services to be rendered and the facilities furnished hereunder, VCM pays the Portfolio Adviser a monthly fee at the annual rate of .20% of the FUND's average daily net assets. Compensation under the Advisory Agreement is calculated and accrued daily and the amounts of the daily accruals are paid monthly. The compensation paid to the Portfolio Adviser will not be reduced by the amount of brokerage commissions received by the Portfolio Adviser or its affiliated broker-dealer pursuant to Section 17(e)(2) of the 1940 Act. For the period August 12, 1993 (commencement of operations) to April 30, 1994 and the fiscal year ended April 30, 1995 the fees paid to the Portfolio Adviser by the prior manager were $9,758 and $34,662, respectively. The Advisory Agreement was approved by the Trustees on March 24, 1995. The Advisory Agreement will remain in force and effect for an initial term of two years, and shall remain in effect thereafter from year to year, provided that such continuance is specifically approved at least annually: (a) (i) by the Trust's Board of Trustees or (ii) by the vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a)(42) of the 1940 Act), and (b) by the affirmative vote of a majority of the Trustees who are not parties to the Advisory Agreement or interested persons of a party to the Advisory Agreement (other than as a Trustee of the Trust), by votes cast in person at a meeting specifically called for such purpose. The Advisory Agreement may be terminated at any time, without the payment of any penalty, by vote of the Trust's Board of Trustees or by vote of a majority of the FUND's outstanding voting securities (as defined in Section 2(a) (42) of the 1940 Act), or by VCM or the Portfolio Adviser on sixty (60) days' written notice to the other party. The Advisory Agreement automatically terminates: (a) in the event of its assignment, the term "assignment" having the meaning defined in Section 2(a)(4) of the 1940 Act, or (b) in the event that the Investment Advisory Contract between the FUND and VCM shall terminate. -25- ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the Fund accrued payments under the Plan amounting to $50,537. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust." Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides -26- that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. > FINANCIAL STATEMENTS Audited financial statements of the Fund for the fiscal year ended April 30, 1995 are attached hereto. -27- APPENDIX A Description of Moody's Investors Service, Inc.'s Bond Ratings: Aaa: Bonds which are rated Aaa judged to be 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 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 fluctuations 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. Note: Moody's applies numerical modifiers, 1, 2 and 3 in the generic rating classifications Aa and A in its bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category, the modifier 2 indicates a mid-range ranking, and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. Description of Moody's Commercial Paper Ratings: Moody's commercial paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Issuers rated Prime-1 or P-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 or P-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. Issuers rated Prime-2 or P-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 alternate liquidity is maintained. A-1 Description of Standard and Poor's Corporation's Bond Ratings: AAA: Bonds rated AAA have the highest rating assigned by S&P to a debt obligation. Capacity to pay interest and repay principal is extremely strong. AA: Bonds rated AA have a very strong capacity to pay interest; and repay principal and differ from the higher rated issues only in small degree. A: Bonds rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. Plus (+) or Minus (-): The ratings AA and A may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. NR: Bonds may lack a S&P rating because no public rating has been requested, because there is insufficient information on which to base a rating, or because S&P does not rate a particular type of obligation as a matter of policy. Description of S&P's Commercial Paper Ratings: S&P's commercial paper ratings are current assessment of the likelihood of timely payment of debts having an original maturity of no more than 365 days. A: Issues assigned this highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-1: This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelming safety characteristics are denoted with a plus (+) sign designation. A-2: Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1." Notes with Respect to All Ratings: Bonds which are unrated expose the investor to risks with respect to capacity to pay interest or repay principal that are similar to the risks of lower-rated bonds. The Fund is dependent on Fund management's judgment, analysis and experience in the evaluation of such bonds. Investors should note that the assignment of a rating to a bond by a rating service may not reflect the effect of recent developments on the issuer's ability to make interest and principal payments. A-2 Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Flexible Tax-Free Bond Fund for the fiscal year ending April 30, 1995. Since its inception on August 12, 1993, your Fund has sought to provide maximum return while seeking a high level of federally tax-free yields.* While 1994 was a year that saw one of the worst bond markets in history, as a result of the bond rally that ended this fiscal year, your Fund shows a strong performance. We are pleased to report that, as indicated in the chart at left, your Fund has outperformed the Lehman Brothers Current Municipal Bond Index, an unmanaged index of municipal bond performance. In addition, for the twelve months ended April 30, 1995, Lipper Analytical Services has ranked the Fund #2 for total return, based on total reinvested performance, out of 197 general municipal debt funds. For the 1-year which ended the preceding month, March 31, 1995, the Fund also ranked #2 in that same general municipal bond fund category. But this time, the category size was slightly smaller at 193 funds. The Fund is waiving certain management fees that are not reflected in these rankings from Lipper Analytical Services. If the fees were reflected then the rankings would change. Please remember, too, that past performance is not a guarantee of future performance. The Year In Review The most severe damage to the fixed-income markets occurred in early 1994, fueled by the Federal Reserve Board's two increases in short-term rates to 3.5%. With mounting evidence that the economy was growing faster than expected, the Fed's action was looked upon as a preemptive strike against inflation. Through most of the spring and summer of 1994, the fixed-income markets drifted, suffering from pervasive fears of accelerating inflation _ despite the string of additional Federal Reserve Board interest rate hikes intended to bring about the "soft landing" for the U.S. economy. At the end of 1994, the market dropped again, pro- (over, please) The following information was represented as a line graph - -------------------------------------------------------------------------------- The Value of a $10,000 Investment in the Blanchard Flexible Tax-Free Bond Fund from inception 8/12/93 through 4/30/95 as compared to the Lehman Brothers Current Municipal Bond Index for the same period --------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Flexible Tax-Free Bond Fund* --------------------------------------- 1 year 10.74% --------------------------------------- since inception 5.83% --------------------------------------- FYE 4/30/94 FYE 4/30/95 FTFBF -0.48% 10.74% LEHMAN BROS -1.01% 5.30% FTFBF $10,000 $9,952 $11,021 LEHMAN BROS $10,000 $9,899 $10,242 Reflects deduction of $75 acct opening fee Blanchard Lehman Brothers Flexible Tax-Free Current Municipal Bond Fund* Bond Index (D) *The Fund is waiving certain management fees and other expenses. If fees were not waived, the returns quoted above and the chart values above would be lower. Total return includes changes in principal value and reinvested distributions. Past performance is no guarantee of future results. (D)Source: The Lehman Brothers Current Municipal Bond Index is an unmanaged index of long-term, investment-grade, tax-exempt municipal bonds. This chart is for comparative purposes only and is not intended to reflect on future performance of the Blanchard Flexible Tax-Free Bond Fund or the index. - -------------------------------------------------------------------------------- pelled by rising rates, year-end tax considerations, and investors selling out of mutual funds. Toward the end of the fourth quarter, the market began a tentative recovery, due in large part to yields that were perceived to be too high, the short supply of municipal bonds, and a general perception that we were nearing the end of Federal Reserve interventions. In early 1995, the market was anticipating another rate increase, and this had been priced into the forward yield curve. The eventual .50% hike in February (which was less than many expected), rumblings from Washington that this would be the last intervention (at least for the near term), and widespread perceptions that the economy was slowing and that rates had overshot on the upside caused the fixed-income markets to take off. As with the precipitous selloff of a year ago, most of the bond market activity occurred within the ensuing five-week period; this time the Fund was positioned to gain. Throughout the past fiscal year, the portfolio was invested in a diverse number of high-quality "essential service" revenue bonds and high-quality state general obligation bonds. At the start of the fiscal year, as interest rates were already high, we adopted a defensive posture by shortening maturities and maintaining up to 25% cash reserves. At the end of 1994, as discount bonds continued to drop in value, we restructured _ deploying cash reserves to purchase many of these deeply discounted, or "de-minimized," bonds. In the first quarter of 1995, as rates dropped, our aggressive positioning paid off, and the Fund reported a total return of 10.74% for the twelve months ended April 30, 1995. Naturally, past performance is no guarantee of future results. The Fund's yield, principal value and investment return will vary with market conditions so that shares, when redeemed, may be worth more or less than their original cost. A Look Ahead For now, the market has priced in economic slowdown and moderate inflation. Any indications to the contrary could startle the market into a correction. The wild card is the severely depreciated U.S. dollar, which the market has so far ignored in favor of focusing on positive news on the domestic front. If the dollar declines much further, market attention will eventually have to shift, likely sparking a selloff. Added to these concerns, prices are up sharply. As a result, we have adopted a slightly more cautious approach _ generally shortening portfolios _ pending resolution of these near-term concerns. Shareholders can rest assured that we will continue our search for tax-free yields and capital gains opportunities in the coming year, maintaining our high-quality focus while closely monitoring the state of the economy. Sincerely, KM:ml Kenneth McAlley Director of Fixed Income Investments, U.S. Trust Company Portfolio Managers of the Blanchard Flexible Tax-Free Bond Fund * Some income may be subject to state and local taxes or to the Federal Alternative Minimum Tax. Consult your tax advisor as to the tax consequences, if any, of this Fund. Distributed by Sheffield Investments, Inc. (1551) 07ARSL0695 BLANCHARD FLEXIBLE TAX-FREE BOND FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Principal Value --------- ----- TAX-EXEMPT SECURITIES (87.97%) Alaska (4.50%) Valdez Alaska Marine Terminal 5.50%, 10/01/28 $1,000,000 $ 877,680 ---------- Arizona (4.58%) Salt River Project Arizona Agriculture 5.00%, 01/01/13 1,000,000 893,870 ---------- Florida (4.61%) Orlando, Florida Utilities Commission on Water & Electricity 5.25%, 10/01/23 1,000,000 899,490 ---------- Georgia (4.85%) Fulton County, Georgia School District 5.625%, 1/01/21 1,000,000 945,460 ---------- Maryland (5.01%) Maryland State Community Development Admin. 5.80%, 04/01/09 1,000,000 975,720 ---------- Massachusetts (5.11%) Massachusetts Housing Finance Authority, 6.30%, 10/01/13 1,000,000 995,630 ---------- New York (30.44%) New York State Power Authority Revenue and General 5.125%, 01/01/10 2,000,000 1,842,520 ---------- New York State Environmental 6.875%, 06/15/10 1,000,000 1,067,160 ---------- New York State Medical Care Facility Finance Agency 6.50%, 08/15/29 1,000,000 1,026,410 ---------- New York State Mortgage Agency Revenue Series 41-A 6.45%, 10/01/14 1,000,000 1,011,770 ---------- Triborough Bridge & Tunnel Authority Revenue 6.00%, 01/01/13 1,000,000 987,040 5,934,900 ---------- (Right Column) Principal Value --------- ----- Ohio (5.13%) (b)Ohio State University General Receipts Series B 4.75%, 12/01/06 $1,000,000 $ 1,000,000 ---------- Texas (4.58%) San Antonio, Texas Electric and Gas Refunding 5.00%, 2/01/14 1,000,000 892,360 ---------- Utah (4.72%) Intermountain Power Agency, Utah Power 5.50%, 07/01/20 1,000,000 919,610 ---------- Washington (9.86%) Washington State Series A 5.75%, 09/01/19 1,000,000 949,750 ---------- King County Washington General Obligation 6.25%, 01/01/34 1,000,000 972,930 1,922,680 Wisconsin (4.58%) Wisconsin State Transportation 5.50%, 07/01/22 1,000,000 892,890 ---------- TOTAL TAX-EXEMPT SECURITIES (IDENTIFIED COST $16,796,907) 17,150,290 Shares ------ TAX-EXEMPT CASH EQUIVALENT SECURITIES (.54%) Dreyfus Tax-Exempt Cash Management Fund 105,885 105,885 ----------- TOTAL TAX-EXEMPT CASH EQUIVALENT SECURITIES (IDENTIFIED COST $105,885) 105,885 ----------- TOTAL INVESTMENTS (IDENTIFIED COST $16,902,792) (a) (88.51%) 17,256,175 CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (11.49%) 2,239,387 ----------- NET ASSETS (100%) $19,495,562 =========== (a) The aggregate cost for federal income tax purposes is $16,902,792 the gross unrealized appreciation is $591,078, the gross unrealized depreciation is $237,695, resulting in net unrealized appreciation of $353,383. (b) Variable rate security. Rate shown reflects the current rate as of April 30, 1995. See notes to financial statements. 3 BLANCHARD FLEXIBLE TAX-FREE BOND FUND (Left Column) STATEMENT OF ASSETS AND LIABILITIES April 30, 1995 Assets: Investments in securities, at value (Identified Cost $16,902,792) (note 1) ................................... $17,256,175 ----------- Receivables for: Investments sold ............................................ 1,925,101 Shares of beneficial interest sold .......................... 36,559 Interest .................................................... 253,429 Investment advisor .......................................... 11,369 Deferred organizational expenses (note 1) ..................... 61,211 ----------- Total assets ............................................ 19,543,844 ----------- Liabilities: Payables for: Dividends ................................................... 11,902 Accrued expenses and other liabilities ........................ 36,380 ----------- Total liabilities ........................................ 48,282 ----------- Net assets ............................................... $19,495,562 =========== Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 3,877,709 shares outstanding) .......................................... $20,737,821 Accumulated overdistributed net investment income ....................................................... (12,275) Accumulated realized loss ..................................... (1,583,367) Unrealized net appreciation of investments 353,383 ----------- Net assets $19,495,562 =========== Net asset value per share $5.03 ===== (Right Column) STATEMENT OF OPERATIONS For the Year Ended April 30, 1995 Investment income: Interest .................................................... $1,244,175 ---------- Expenses: Investment management fee (note 2) ........................................ $151,593 Accounting fees ................................... 81,015 Plan of distribution (note 3) ..................... 50,537 Transfer agent fees ............................... 48,147 Trustees' fees, retirement plan curtailment and other expenses (note 5) ............................... 28,893 Professional fees ................................. 28,599 Registration fees ................................. 22,388 Shareholder reports and notices ................... 19,649 Organizational expenses (note 1) ........................................ 17,890 Custodian fees .................................... 8,731 Other ............................................. 2,318 -------- Total expenses 459,760 Less: Fees voluntarily waived and expenses absorbed by Manager and Distributor (note 2) (248,019) -------- Net expenses ................................................. 211,741 ---------- Net investment income 1,032,434 ---------- Realized and unrealized gain (loss)-net (note 1): Realized gain (loss) on investments in securities -net ..............................................(1,143,934) Change in unrealized appreciation on investments -net ............................................. 1,890,650 Net realized and unrealized gains ............................ 746,716 ---------- Net increase in net assets resulting from operations ............................................ $1,779,150 ========== See notes to financial statements. 4 BLANCHARD FLEXIBLE TAX-FREE BOND FUND STATEMENT OF CHANGES IN NET ASSETS
For the period August 12,1993* For the (commencement Year Ended of operations) to April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment income-net ............................................. $1,032,434 $ 616,713 ---------- ----------- Realized loss-net ................................................. (1,143,934) (380,822) Change in unrealized appreciation or (depreciation)-net ........... 1,890,650 1,537,267) ---------- ----------- Net increase (decrease) in net assets resulting from operations .... 1,779,150 (1,301,376) ---------- ----------- Dividends and distributions to shareholders: Investment income-net ............................................. (1,032,434) (616,113) Dividends in excess of investment income-net ...................... (12,875) -- Realized gain on investments-net .................................. - (58,611) ---------- ----------- (1,045,309) (674,724) ---------- ----------- Transactions in shares of beneficial interest- net increase (decrease) (note 6) .................................. (4,505,338) 22,243,159 ---------- ----------- Net increase (decrease) in net assets ............................ (3,771,497) 20,267,059 Net assets: Beginning of year ................................................. 23,267,059 3,000,000 ---------- ----------- End of year (including overdistributed net investment income of $12,275 and undistributed net investment income of $600, respectively) .................................................... $19,495,562 $23,267,059 =========== =========== - ---------- *Commencement of operations
See notes to financial statements. 5 BLANCHARD FLEXIBLE TAX-FREE BOND FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1 - Organization and Accounting Policies: Blanchard Flexible Tax-Free Bond Fund (the "Fund") is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940, as amended (the "Act"). The Fund had no operations before August 12, 1993 other than the sale of 600,000 shares of beneficial interest for $3,000,000 to Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on the 61st day. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. B. Accounting for Investments and Investment Income-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable and non-taxable income to its shareholders. Accordingly, no federal income tax provision is required. D. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income and net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income and net realized capital gains for tax purposes, they are reported as distributions of paid-in capital. E. Organizational Expenses-The Fund's Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to $89,448. The Fund reimbursed the Manager 6 BLANCHARD FLEXIBLE TAX-FREE BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 for such expenses and has deferred and is amortizing such expenses on the straight-line method over five years from the date of commencement of the Fund's operations. F. Other-Certain expenses of the Blanchard Funds are allocated among the funds based upon their relative average net assets. NOTE 2 - Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Adviser described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of .75% of the Fund's average daily net assets. For the year ended April 30, 1995, the Manager and Distributor voluntarily waived the advisory fee and distribution fee, which amounted to $127,835 and $50,537, respectively, and absorbed $69,647 of other expenses of the Fund. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses, are subject to the expense limitations imposed by one of the states in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed such limitation. Certain officers and/or Trustees of the Fund are officers/directors of the Manager. The Manager has a sub-advisory agreements with U.S. Trust (the "Portfolio Adviser"). All fees for such services are paid by the Manager. The Manager has advised the Fund that the fees paid to the Portfolio Advisor were $34,662 for the year ended April 30, 1995. NOTE 3 - Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor"), an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the plan, the Fund may pay distribution fees not to exceed .25% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after August 12, 1993, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $508,529. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. 7 BLANCHARD FLEXIBLE TAX-FREE BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 4 - Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Flexible Tax-Free Bond Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2)a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. NOTE 5 - Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $35,861,393 and $39,179,733, respectively. The Manager has advised the Fund that, for the year ended April 30, 1995, it incurred costs, which were absorbed by the Manager, amounting to $23,624 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $5,230. As indicated in Note4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $18,499 was recorded to reflect the previously unrecognized prior service cost of the independent director/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $23,729 of accrued pension expense. NOTE 6 - Shares of Beneficial Interest:
For the For the Period Year Ended August 12, 1993* to April 30, 1995 April 30, 1994 ------------------------ ------------------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold .................................. 2,686,852 $12,962,463 7,344,374 $37,526,118 Reinvestment of dividends and distributions ........................ 171,998 825,614 114,233 575,313 --------- ----------- --------- ----------- 2,858,850 13,788,077 7,458,607 38,101,431 Repurchased ........................... (3,854,437) (18,293,415) (2,585,311) (12,858,272) --------- ----------- --------- ----------- Net increase (decrease) ............... (995,587) (4,505,338) 4,873,296 $25,243,159 ======== ========== ========= =========== - ------------ *Commencement of operations.
8 BLANCHARD FLEXIBLE TAX-FREE BOND FUND NOTES TO FINANCIAL STATEMENTS (continued) April 30, 1995 NOTE 7 - Federal Income Taxes: Capital losses incurred after October 31 ("post-October losses") within the taxable year are deemed to arise on the first business day of the Fund's next taxable year. The Fund incurred and will elect to defer net capital losses of approximately $822,000 during fiscal 1995. At April 30, 1995, the Fund had a net capital loss carryover of $748,924 which is available through April 30, 2003 to offset future capital gains. To the extent that these carryover losses are used to offset future capital gains, it is probable that the gains so offset will not be distributed to shareholders. NOTE 8 - Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the period August 12, 1993 For the (commencement Year Ended of operations) to April 30, 1995 April 30, 1994 -------------- -------------- Per Share Operating Performance: Net asset value, beginning of period ...................... $4.77 $5.00 ----- ----- Income from investment operations: Net investment income .................................... .24 .18 ----- ----- Net gains or losses on securities (both realized and unrealized) .26 (.20) Net income (loss) from investment operations .......... .50 (.02) ----- ------ Less dividends and distributions: Dividends from investment income-net ..................... (.23) (.18) Dividends in excess of investment income-net ............. (.01) - Distributions from realized gains-net .................... - (.03) Change in net asset value ............................. .26 (.23) ----- ----- Net asset value, end of period ............................ $5.03 $4.77 ===== ===== Total return (not annualized) ............................. 10.74% (.48%) Ratios/Supplemental Data: Net assets, end of period ($ Million) .................... $ 19 $ 23 Ratio of expenses to average net assets .................. 1.00%(2) 0%*(2)(1) Ratio of net investment income to average net assets ..... .87%(2) 6.79%(2)(1) Portfolio turnover ........................................ 170% 190% - ----------- (1) Annualized. (2) The ratios of expenses to average net assets and net investment income to average net assets would have been 2.17% and 6.04%, respectively, for the year ended April 30, 1995 and 2.22% and 4.57% (annualized), respectively, for the period ended April 30, 1994, if the Fund's expenses had not been voluntarily waived and absorbed by the Manager and Distributor (see notes 2 and 3).
9 BLANCHARD FLEXIBLE TAX-FREE BOND FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Flexible Tax-Free Bond Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Flexible Tax-Free Bond Fund (the "Fund") at April 30, 1995, the results of its operations for the year then ended, and the changes in its net assets and the financial highlights for the year ended April 30, 1995 and for the period August 12, 1993 (commencement of operations) through April 30, 1994, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 1995 FEDERAL TAX NOTICE (Unaudited) In accordance with Federal tax law the Fund hereby designates all dividends paid from investment income-net during the fiscal year ended April 30, 1995 as "exempt-interest dividends" (not subject to regular Federal personal income taxes). 10 Portfolio Adviser United States Trust Company of New York Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Flexible Tax-Free Bond Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 Blanchard Flexible Tax-Free Bond Fund Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD WORLDWIDE EMERGING MARKETS FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Worldwide Emerging Markets Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History ............................................ 2 Investment Objective and Policies .......................................... 2 Risk Factors and Special Considerations .................................... 17 Investment Restrictions .................................................... 21 Portfolio Transactions ..................................................... 22 Computation of Net Asset Value ............................................. 24 Performance Information .................................................... 25 Additional Purchase and Redemption Information ............................. 26 Tax Matters ................................................................ 27 The Management of the FUND ................................................. 34 Management Services ........................................................ 39 Portfolio Advisory Services ................................................ 39 Administrative Services .................................................... 40 Distribution Plan .......................................................... 40 Description of the FUND .................................................... 41 Shareholder Reports ........................................................ 42 Appendix A ................................................................. A-1 Financial Statements ....................................................... B-1 Manager Virtus Capital Management, Inc. Portfolio Advisers Martin Currie Inc. (Equity sector) OFFITBANK (Fixed Income sector) Distributor Federated Securities Corp. Custodian United States Trust Company of New York Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the FUND's Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. INVESTMENT OBJECTIVE AND POLICIES The following information supplements, and should be read in conjunction with, the sections in the FUND's Prospectus entitled "Investment Objective and Policies". The FUND's investment objective is to provide capital appreciation and current income by investing primarily in equity and fixed income securities in emerging markets around the world. This objective is a fundamental policy and may not be changed except by a majority vote of shareholders. The FUND, as a non-diversified management investment company, has the following restriction at the close of each quarter of its taxable year: (a) with respect to 50% of the FUND's total assets, the FUND may not invest more than 5% of its total assets, at market value, in the securities of one issuer (except the securities of the U.S. Government, its agencies and instrumentalities) and (b) with respect to the other 50% of the FUND's total assets, the FUND may not invest more than 25% of the market value of its total assets in a single issuer (except the securities of the U.S. Government, its agencies and instrumentalities). These two restrictions, hypothetically, could give rise to the FUND having securities, other than U.S. Government securities, of as few as twelve issuers. The FUND will invest primarily in securities (i) of issuers for which the principal securities trading market is in an emerging market country; (ii) traded in any market, of issuers that alone or on a consolidated basis derive 50% or more of their revenue from either goods produced, sales made or services performed in emerging market countries; or (iii) of issuers organized under the laws of, and with a principal office in, an emerging market country (hereinafter referred to as "Emerging Market Securities".) Determination as to eligibility will be made by the Portfolio Advisers based on publicly available information and inquiries made to the companies. "Emerging Market Equity Securities" means common and preferred stock (including convertible preferred stock), convertible bonds and notes, warrants and rights, units, interests in trusts and partnerships and American, European, Global or any other types of Depositary Receipts. Under normal conditions, the Fund expects to maintain a minimum of 65% of its assets in Emerging Market Equity Securities. Currently, investing in many emerging market countries is not feasible or may involve unacceptable political risks. The Portfolio Advisers will focus their investments on those emerging market countries in which they believe the economies are developing strongly and in which the markets are becoming more sophisticated. As markets in other countries develop, the Portfolio Advisers expect to expand and further diversify the emerging market countries in which they invest. The Portfolio Advisers do not intend to invest in any security in a country where the currency is not freely convertible to U.S. dollars, unless a Portfolio Adviser has obtained the necessary governmental licensing to convert such currency or other appropriately licensed or sanctioned contractual guarantee to protect such investment against loss of that currency's external value, or the Portfolio Adviser has a reasonable expectation at the time the investment is made that such governmental licensing or other appropriately licensed or sanctioned guarantee would be obtained or that the currency in which the security is quoted would be freely convertible at the time of any proposed sale of the security by the FUND. The FUND'S definition of Emerging Market Securities includes securities of companies that may have characteristics and business relationships common to companies in a country or countries other than an emerging market country. As a result, the value of the securities of such companies may reflect economic and market forces applicable to other countries, as well as to an emerging market country. The FUND believes, however, that investment in such companies will be appropriate because the FUND will invest only in those companies which, in its view, have sufficiently strong exposure to economic and market forces in an emerging market country such that their value will tend to reflect developments in such emerging market country to a greater extent than developments in another country or countries. For example, a Portfolio Adviser -2- may invest in companies organized and located in countries other than an emerging market country, including companies having their entire production facilities outside of an emerging market country, when securities of such companies meet one or more elements of the FUND's definition of an Emerging Market Security and so long as the Portfolio Adviser believes at the time of investment that the value of the company's securities will reflect principally conditions in such emerging market country. The FUND may invest indirectly in securities of emerging market country issuers through sponsored or unsponsored American Depositary Receipts ("ADRs"), European Depository Receipts ("EDRs"), Global Depositary Receipts ("GDRs") and other types of Depositary Receipts (which, together with ADRs, EDRs and GDRs, are hereinafter referred to as "Depositary Receipts"). Depositary Receipts may not necessarily be denominated in the same currency as the underlying securities into which they may be converted. In addition, the issuers of the stock of unsponsored Depositary Receipts are not obligated to disclose material information in the United States and, therefore, there may not be a correlation between such information and the market value of the Depositary Receipts. EDRs and ADRs are Depositary Receipts typically issued by a United States bank or trust company which evidence ownership of underlying securities issued by a foreign corporation. GDRs and other types of Depositary Receipts are typically issued by foreign banks or trust companies, although they also may be issued by either a foreign or a United States corporation. Generally, Depositary Receipts in registered form are designed for use in the United States securities markets and Depositary Receipts in bearer form are designed for use in securities markets outside the United States. For purposes of the FUND's investment policies, the FUND's investments in ADRs, GDRs and other types of Depositary Receipts will be deemed to be investments in the underlying securities. Depositary Receipts other than those denominated in U.S. dollars will be subject to foreign currency exchange rate risk. Certain Depositary Receipts may not be listed on an exchange and therefore may be illiquid securities. "Emerging Market Fixed Income Securities" means fixed income securities of both governmental and corporate issuers (other than convertibles) of any quality or maturity. Emerging Market Fixed Income Securities often are considered to be of a credit quality below investment grade. "Investment grade" fixed income securities are those rated within the four highest ratings categories of Standard & Poor's Corporation ("S&P") or Moody's Investors Service, Inc. ("Moody's") or, if a security is unrated, determined to be of comparable quality. Securities rated BBB by S&P and Baa by Moody's are investment grade fixed income securities but may have speculative characteristics. Many emerging market fixed income securities are not rated by U.S. ratings agencies. Investment in non-investment grade fixed income securities involves a high degree of risk and can be speculative. "Money Market Instruments" means short-term (less than twelve months to maturity) investments in (a) obligations of the United States or emerging market country governments, their respective agencies or instrumentalities; (b) bank deposits and bank obligations (including certificates of deposit, time deposits and bankers' acceptances) of U.S. or emerging market country banks denominated in any currency; (c) floating rate securities and other instruments denominated in any currency issued by international development agencies; (d) finance company and corporate commercial paper and other short-term corporate debt obligations of U.S. and emerging market country corporations meeting the credit quality standards set by the FUND's Board of Trustees; and (e) repurchase agreements with banks and broker-dealers with respect to such securities. While the FUND does not intend to limit the amount of its assets invested in Money Market Instruments, except to the extent believed necessary to achieve its investment objective, it does not expect under normal market conditions to have a substantial portion of its assets invested in Money Market Instruments. However, when VCM determines that adverse market conditions exist, the FUND may adopt a temporary defensive posture and invest its entire portfolio in Money Market Instruments. In addition, the FUND may -3- invest in Money Market Instruments in anticipation of investing cash positions. To the extent the FUND is so invested, the FUND's investment objective may not be achieved. Securities in which the FUND may invest include those that are neither listed on a stock exchange nor traded over-the-counter. As a result of the absence of a public trading market for these securities, they may be less liquid than publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized from these sales could be less than those originally paid by the FUND or less than what may be considered the fair value of such securities. Further, companies whose securities are not publicly traded may not be subject to the disclosure and other investor protection requirements which may be applicable if their securities were publicly traded. If such securities are required to be registered under the securities laws of one or more jurisdictions before being resold, the FUND may be required to bear the expenses of registration. The FUND does not intend to invest more than 15% of its total assets in non-publicly traded or otherwise illiquid securities. The FUND, together with any of its "affiliated persons" (as defined in the Investment Company Act of 1940, as amended) (the "1940 Act"), may only purchase up to 3% of the total outstanding securities of any underlying investment company. Accordingly, when the FUND or such "affiliated persons" hold shares of any of the underlying investment companies, the FUND's ability to invest fully in shares of those investment companies is restricted, and each Portfolio Adviser must then, in some instances, select alternative investments that would not have been its first preference. The 1940 Act also provides that an underlying investment company whose shares are purchased by the FUND will be obligated to redeem shares held by the FUND and its affiliates only in an amount up to 1% of the underlying investment company's outstanding securities during any period of less than 30 days. Shares held by the FUND and its affiliates in excess of 1% of an underlying investment company's outstanding securities therefore will be considered not readily marketable securities, which together with other such illiquid securities may not exceed 15% of the FUND's net assets. In certain circumstances, an underlying investment company may determine to make payment of a redemption by the FUND wholly or partly by a distribution in kind of securities from its portfolio, in lieu of cash, in conformity with rules of the Securities and Exchange Commission. In such cases, the FUND may hold securities distributed by an underlying investment company until the Portfolio Adviser determines that it is appropriate to dispose of such securities. There can be no assurance that funds for investing in certain emerging market countries will be available for investment. The FUND does not intend to invest in such funds unless, in the judgment of a Portfolio Adviser, the potential benefits of such investment justify the payment of any applicable premium or sales charge. To the extent that the FUND's assets are not invested in securities of issuers whose principal activities are in emerging markets, the remainder of the assets may be invested in: (i) equity or debt securities of corporate or governmental issuers located in industrialized countries; and (ii) money market securities of the type described above. The Portfolio Adviser for the Fixed Income sector will not invest in fixed income securities rated lower than Caa by Moody's and CCC by S&P, or, if unrated, of comparable quality in the Portfolio Adviser's opinion. Fixed income securities rated Baa by Moody's and BBB by Standard & Poor's are considered investment grade obligations which lack outstanding investment characteristics and may have speculative characteristics with respect to capacity to pay interest and repay principal and to be of poor standing. In addition, for temporary defensive purposes, the Portfolio Advisers may invest less than 65% of the Fund's -4- assets in securities of issuers whose principal activities are in emerging markets, in which case the Fund may invest in U.S. Treasury securities and high quality fixed income securities. The FUND is a "non-diversified" investment company portfolio, which means that the FUND is not limited in the proportion of its assets that may be invested in the securities of a single issuer. However, the FUND's Portfolio Advisers typically invest in a large number of issuers spread among a large number of countries. Furthermore, the FUND intends to comply with the diversification requirements imposed by the U.S. Internal Revenue Code of 1986, as amended, for qualification as a regulated investment company. See "Tax Matters" in the Prospectus and in the FUND's Statement of Additional Information. The FUND intends to conduct its operations so as to qualify as a "regulated investment company" for purposes of the Internal Revenue Code of 1986, as amended (the "Code"), which will relieve the FUND of any liability for Federal income tax to the extent its earnings are distributed to shareholders. See "Tax Matters". To so qualify, among other requirements, the FUND will limit its investments so that, at the close of each calendar quarter, (i) not more than 25% of the market value of the FUND's total assets will be invested in the securities of a single issuer, and (ii) with respect to 50% of the market value of its total assets, not more than 5% of the market value of its total assets will be invested in the securities of a single issuer and the FUND will not own more than 10% of the outstanding voting securities of a single issuer. For purposes of the FUND's requirements to maintain diversification for tax purposes, the issuer of a loan participation will be the underlying borrower. In cases where the FUND does not have recourse directly against the borrower, both the borrower and each agent bank and co-lender interposed between the FUND and the borrower will be deemed issuers of the loan participation for tax diversification purposes. The FUND's investments in debt securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities ("U.S. Government Securities") are not subject to these limitations. Since the FUND, as a non-diversified investment company may invest in a smaller number of individual issuers than a diversified investment company, an investment in the FUND may, under certain circumstances, present greater risk to an investor than an investment in a diversified company. Options and Futures Strategies Through the writing and purchase of options and the purchase and sale of stock index futures contracts, interest rate futures contracts, foreign currency futures contracts and related options on such futures contracts, the Portfolio Adviser may at times seek to hedge against a decline in the value of securities included in the FUND's portfolio or an increase in the price of securities which it plans to purchase for the FUND or to reduce risk or volatility while seeking to enhance investment performance. Expenses and losses incurred as a result of such hedging strategies will reduce the FUND's current return. The ability of the FUND to engage in the options and futures strategies described below will depend on the availability of liquid markets in such instruments. Markets in options and futures with respect to stock indices, U.S. Government securities and foreign currencies are relatively new and still developing. The FUND, however, will not enter into an option or futures position unless a liquid secondary market for such option or futures contract is believed by FUND management to exist. There is no assurance that the FUND will be able to effect closing transactions at any particular time or at an acceptable price. Reasons for the absence of a liquid secondary market on an Exchange include the following: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an Exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (iv) unusual or unforeseen circumstances may interrupt normal operations on an Exchange; (v) the facilities of an Exchange or the Options Clearing -5- Corporation ("OCC") may not at all times be adequate to handle current trading volume; or (vi) one or more Exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market thereon would cease to exist, although outstanding options on that Exchange that had been issued by the OCC as a result of trades on that Exchange would continue to be exercisable in accordance with their terms. Low initial margin deposits made upon the opening of a futures position and the writing of an option involve substantial leverage. As a result, relatively small movements in the price of the contract can result in substantial unrealized gains or losses. However, to the extent the FUND purchases or sells futures contracts and options on futures contracts and purchases and writes options on securities and securities indexes for hedging purposes, any losses incurred in connection therewith should, if the hedging strategy is successful, be offset, in whole or in part, by increases in the value of securities held by the FUND or decreases in the prices of securities the FUND intends to acquire. It is impossible to predict the amount of trading interest that may exist in various types of options or futures. Therefore, no assurance can be given that the FUND will be able to utilize these instruments effectively for the purposes stated below. Furthermore, the FUND's ability to engage in options and futures transactions may be limited by tax considerations. Although the FUND will only engage in options and futures transactions for limited purposes, it will involve certain risks which are described in the Prospectus. The FUND will not engage in options and futures transactions for leveraging purposes. When the FUND purchases a futures contract, an amount of cash or cash equivalents or high quality debt securities will be deposited in a segregated account with the FUND's custodian so that the amount so segregated, plus the initial deposit and variation margin held in the account of its broker, will at all times equal the value of the futures contract, thereby assuring that the use of such futures is unleveraged. Writing Covered Options on Securities The FUND may write covered call options and covered put options on optionable securities (stocks, bonds, foreign exchange, related futures, options and options on futures) of the types in which it is permitted to invest in seeking to attain its objective. Call options written by the FUND give the holder the right to buy the underlying securities from the FUND at a stated exercise price; put options give the holder the right to sell the underlying security to the FUND at a stated price. The FUND may write only covered options, which 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 comparable securities satisfying the cover requirements of securities exchanges). In the case of put options, the FUND will maintain, in a segregated account, cash or short-term U.S. Government securities with a value equal to or greater than the exercise price of the underlying securities or will hold a purchased put option with a higher strike price than the put written. The FUND may also write combinations of covered puts and calls on the same underlying security. The FUND will receive a premium from writing a put or call option, which increases the FUND's return in the event the option expires unexercised or is closed out at a profit. The amount of the premium will reflect, among other things, the relationship of the market price of the underlying security to the exercise price of the option, the term of the option and the volatility of the market price of the underlying security. By writing a call option, the FUND limits its opportunity to profit from any increase in the market value of the underlying security above the exercise price of the option. By writing a put option, the FUND assumes the risk that it may be required to purchase the underlying security for an exercise price higher than its market value at the time it is exercised resulting in a potential capital loss if the purchase price is greater than -6- the underlying security's current market value minus the amount of the premium received, unless the security subsequently appreciates in value. The FUND may terminate an option that it has written prior to its expiration by entering into a closing purchase transaction in which it purchases an option having the same terms as the option written. The FUND will realize a profit or loss from such transaction if the cost of such transaction is less or more, respectively, than the premium received from the writing of the option. In the case of a put option, any loss so incurred may be partially or entirely offset by the premium received from a simultaneous or subsequent sale of a different put option. Because increases in the market price of a call option will generally reflect increases in the market price of the underlying security, any loss resulting from the repurchase of a call option is likely to be offset in whole or in part by unrealized appreciation of the underlying security owned by the FUND. Options written by the FUND will normally have expiration dates not more than one year from the date written. The exercise price of the options may be below ("in-the-money"), equal to ("at-the-money") or above ("out-of-the-money") the current market price of the underlying securities at the times the options are written. The FUND may engage in buy-and-write transactions in which the FUND simultaneously purchases a security and writes a call option thereon. Where a call option is written against a security subsequent to the purchase of that security, the resulting combined position is also referred to as buy-and-write. Buy-and-write transactions using in-the-money call options may be utilized when it is expected that the price of the underlying security will remain flat or decline moderately during the option period. In such a transaction, the FUND's maximum gain will be the premium received from writing the option reduced by any excess of the price paid by the FUND for the underlying security over the exercise price. Buy-and-write transactions using at-the-money call options may be utilized when it is expected that the price of the underlying security will remain flat or advance moderately during the option period. In such a transaction, the FUND's gain will be limited to the premiums received from writing the option. Buy-and-write transactions using out-of-the-money call options may be utilized when it is expected that the premiums received from writing the call option plus the appreciation in market price of the underlying security up to the exercise price will be greater than the appreciation in the price of the underlying security alone. In any of the foregoing situations, if the market price of the underlying security declines, the amount of such decline will be offset wholly or in part by the premium received and the FUND may or may not realize a loss. To the extent that a secondary market is available on the Exchanges, the covered call option writer may liquidate his position prior to the assignment of an exercise notice by entering a closing purchase transaction for an option of the same series as the option previously written. The cost of such a closing purchase, plus transaction costs, may be greater than the premium received upon writing the original option, in which event the writer will have incurred a loss in the transaction. Purchasing Put and Call Options on Securities The FUND may purchase put options to protect its portfolio holdings in an underlying security against a decline in market value. Such hedge protection is provided during the life of the put option since the FUND, as holder of the put option, is able to sell the underlying security at the put exercise price regardless of any decline in the underlying security's market price. In order for a put option to be profitable, the market price of the underlying security must decline sufficiently below the exercise price to cover the premium and transaction costs. By using put options in this manner, the FUND will reduce any profit it might otherwise have realized in the underlying security by the premium paid for the put option and by transaction costs. -7- The FUND may also purchase call options to hedge against an increase in prices of securities that it wants ultimately to buy. Such hedge protection is provided during the life of the call option since the FUND, as holder of the call option, is able to buy the underlying security at the exercise price regardless of any increase in the underlying security's market price. In order for a call option to be profitable, the market price of the underlying security must rise sufficiently above the exercise price to cover the premium and transaction costs. By using call options in this manner, the FUND will reduce any profit it might have realized had it bought the underlying security at the time it purchased the call option by the premium paid for the call option and by transaction costs. Purchase and Sale of Options and Futures on Stock Indices The FUND may purchase and sell options on stock indices and stock index futures as a hedge against movements in the equity markets. Options on stock indices are similar to options on specific securities except that, rather than the right to take or make delivery of the specific security at a specific price, an option on a stock index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of that stock index is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing price of the index and the exercise price of the option expressed in dollars multiplied by a specified multiple. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike options on specific securities, all settlements of options on stock indices are in cash and gain or loss depends on general movements in the stocks included in the index rather than on price movements in particular stocks. Currently, index options traded include the S&P 100 Index, the S&P 500 Index, the NYSE Composite Index, the AMEX Market Value Index, the National Over-the-Counter Index and other standard broadly based stock market indices. Options are also traded in certain industry or market segment indices such as the Oil Index, the Computer Technology Index and the Transportation Index. A stock index futures contract is an agreement in which one party agrees to deliver to the other an amount of cash equal to a specific dollar amount multiplied by the difference between the value of a specific stock index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of securities is made. If the Portfolio Adviser expects general stock market prices to rise, it might purchase a call option on a stock index or a futures contract on that index as a hedge against an increase in prices of particular equity securities they want ultimately to buy. If in fact the stock index does rise, the price of the particular equity securities intended to be purchased may also increase, but that increase would be offset in part by the increase in the value of the FUND's index option or futures contract resulting from the increase in the index. If, on the other hand, the Portfolio Adviser expects general stock market prices to decline, it might purchase a put option or sell a futures contract on the index. If that index does in fact decline, the value of some or all of the equity securities in the FUND's portfolio may also be expected to decline, but that decrease would be offset in part by the increase in the value of the FUND's position in such put option or futures contract. Purchase and Sale of Interest Rate Futures The FUND may purchase and sell U.S. dollar interest rate futures contracts on U.S. Treasury bills, notes and bonds and non-U.S. dollar interest rate futures contracts on foreign bonds for the purpose of -8- hedging fixed income and interest sensitive securities against the adverse effects of anticipated movements in interest rates. The FUND may purchase futures contracts in anticipation of a decline in interest rates when it is not fully invested in a particular market in which it intends to make investments to gain market exposure that may in part or entirely offset an increase in the cost of securities it intends to purchase. The FUND does not consider purchases of futures contracts to be a speculative practice under these circumstances. In a substantial majority of these transactions, the FUND will purchase securities upon termination of the futures contract. The FUND may sell U.S. dollar and non-U.S. dollar interest rate futures contracts in anticipation of an increase in the general level of interest rates. Generally, as interest rates rise, the market value of the fixed income securities held by the FUND will fall, thus reducing the net asset value of the FUND. This interest rate risk can be reduced without employing futures as a hedge by selling long-term fixed income securities and either reinvesting the proceeds in securities with shorter maturities or by holding assets in cash. This strategy, however, entails increased transaction costs to the FUND in the form of dealer spreads and brokerage commissions. The sale of U.S. dollar and non-U.S. dollar interest rate futures contracts provides an alternative means of hedging against rising interest rates. As rates increase, the value of the FUND's short position in the futures contracts will also tend to increase, thus offsetting all or a portion of the depreciation in the market value of the FUND's investments which are being hedged. While the FUND will incur commission expenses in entering and closing out futures positions (which is done by taking an opposite position from the one originally entered into, which operates to terminate the position in the futures contract), commissions on futures transactions are lower than transaction costs incurred in the purchase and sale of portfolio securities. Options on Stock Index Futures Contracts and Interest Rate Futures Contracts The FUND may purchase and write call and put options on stock index and interest rate futures contracts. The FUND may use such options on futures contracts in connection with its hedging strategies in lieu of purchasing and writing options directly on the underlying securities or stock indices or purchasing and selling the underlying futures. For example, the FUND may purchase put options or write call options on stock index futures or interest rate futures, rather than selling futures contracts, in anticipation of a decline in general stock market prices or rise in interest rates, respectively, or purchase call options or write put options on stock index or interest rate futures, rather than purchasing such futures, to hedge against possible increases in the price of equity securities or debt securities, respectively, which the FUND intends to purchase. Purchase and Sale of Currency Futures Contracts and Related Options In order to hedge its portfolio and to protect it against possible variations in foreign exchange rates pending the settlement of securities transactions, the FUND may buy or sell foreign currencies or may deal in forward currency contracts. The FUND may also invest in currency futures contracts and related options. If a fall in exchange rates for a particular currency is anticipated, the FUND may sell a currency futures contract or a call option thereon or purchase a put option on such futures contract as a hedge. If it is anticipated that exchange rates will rise, the FUND may purchase a currency futures contract or a call option thereon or sell (write) a put option to protect against an increase in the price of securities denominated in a particular currency the FUND intends to purchase. These futures contracts and related options thereon will be used only as a hedge against anticipated currency rate changes, and all options on currency futures written by the FUND will be covered. -9- A currency futures contract sale creates an obligation by the FUND, as seller, to deliver the amount of currency called for in the contract at a specified future time for a specified price. A currency futures contract purchase creates an obligation by the FUND, as purchaser, to take delivery of an amount of currency at a specified future time at a specified price. Although the terms of currency futures contracts specify actual delivery or receipt, in most instances the contracts are closed out before the settlement date without the making or taking of delivery of the currency. Closing out of a currency futures contract is effected by entering into an offsetting purchase or sale transaction. Unlike a currency futures contract, which requires the parties to buy and sell currency on a set date, an option on a currency futures contract entitles its holder to decide on or before a future date whether to enter into such a contract or let the option expire. The FUND will write (sell) only covered put and call options on currency futures. This means that the FUND will provide for its obligations upon exercise of the option by segregating sufficient cash or short-term obligations or by holding an offsetting position in the option or underlying currency future, or a combination of the foregoing. The FUND will, so long as it is obligated as the writer of a call option on currency futures, own on a contract-for-contract basis an equal long position in currency futures with the same delivery date or a call option on stock index futures with the difference, if any, between the market value of the call written and the market value of the call or long currency futures purchased maintained by the FUND in cash, Treasury bills, or other high-grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the call purchased by the FUND falls below 100% of the market value of the call written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high-grade short-term obligations equal in value to the difference. Alternatively, the FUND may cover the call option through segregating with the custodian an amount of the particular foreign currency equal to the amount of foreign currency per futures contract option times the number of options written by the FUND. In the case of put options on currency futures written by the FUND, the FUND will hold the aggregate exercise price in cash, Treasury bills, or other high-grade short-term obligations in a segregated account with its custodian, or own put options on currency futures or short currency futures, with the difference, if any, between the market value of the put written and the market value of the puts purchased or the currency futures sold maintained by the FUND in cash, Treasury bills or other high-grade short-term obligations in a segregated account with its custodian. If at the close of business on any day the market value of the put options purchased or the currency futures sold by the FUND falls below 100% of the market value of the put options written by the FUND, the FUND will so segregate an amount of cash, Treasury bills or other high-grade short-term obligations equal in value to the difference. If other methods of providing appropriate cover are developed, the FUND reserves the right to employ them to the extent consistent with applicable regulatory and exchange requirements. In connection with transactions in stock index options, stock index futures, interest rate futures, foreign currency futures and related options on such futures, the FUND will be required to deposit as "initial margin" an amount of cash and short-term U.S. Government securities generally equal to from 5% to 10% of the contract amount. Thereafter, subsequent payments (referred to as "variation margin") are made to and from the broker to reflect changes in the value of the futures contract. Options on Foreign Currencies The FUND may purchase and write options on foreign currencies to enhance investment performance and for hedging purposes in a manner similar to that in which futures contracts on foreign currencies, or forward contracts, will be utilized as described above. For example, a decline in the dollar value of a foreign currency in which portfolio securities are denominated will reduce the dollar value of such -10- securities, even if their value in the foreign currency remains constant. In order to protect against such diminutions in the value of portfolio securities, the FUND may purchase put options on the foreign currency. If the value of the currency does decline, the FUND will have the right to sell such currency for a fixed amount in dollars and will thereby offset, in whole or in part, the adverse effect on its portfolio which otherwise would have resulted. Conversely, where a rise in the dollar value of a currency in which securities to be acquired are denominated is projected, thereby increasing the cost of such securities, the FUND may purchase call options thereon. The purchase of such options could offset, at least partially, the effects of the adverse movements in exchange rates. As in the case of other types of options, however, the benefit to the FUND deriving from purchases of foreign currency options will be reduced by the amount of the premium and related transaction costs. In addition, where currency exchange rates do not move in the direction or to the extent anticipated, the FUND could sustain losses on transactions in foreign currency options which would require it to forego a portion or all of the benefits of advantageous changes in such rates. Also, where the FUND anticipates a decline in the dollar value of foreign currency denominated securities due to adverse fluctuations in exchange rates it could, instead of purchasing a put option, write a call option on the relevant currency. If the expected decline occurs, the option will most likely not be exercised, and the diminution in value of portfolio securities will be offset by the amount of the premium received. Similarly, instead of purchasing a call option to hedge against an anticipated increase in the dollar cost of securities to be acquired, the FUND could write a put option on the relevant currency which, if the currency moves in the manner projected, will expire unexercised and allow the FUND to hedge such increased cost up to the amount of the premium. As in the case of other types of options, however, the writing of a foreign currency option will constitute only a partial hedge up to the amount of the premium, and only if rates move in the expected direction. If this does not occur, the option may be exercised and the FUND would be required to purchase or sell the underlying currency at a loss which may not be offset by the amount of the premium. Through the writing of options on foreign currencies, the FUND also may be required to forego all or a portion of the benefits which might otherwise have been obtained from favorable movements in exchange rates. The FUND intends to write covered call options on foreign currencies. A call option written on a foreign currency by the FUND is "covered" if the FUND owns the underlying foreign currency covered by the call or has an absolute and immediate right to acquire that foreign currency without additional cash consideration (or for additional cash consideration held in a segregated account by its custodian, which acts as the FUND's custodian, or by a designated sub-custodian) upon conversion or exchange of other foreign currency held in its portfolio. A call option is also covered if the FUND has a call on the same foreign currency and in the same principal amount as the call written where the exercise price of the call held (a) is equal to or less than the exercise price or the call written or (b) is greater than the exercise price of the call written if the difference is maintained by the FUND in cash, U.S. Government Securities and other high-grade liquid debt securities in a segregated account with its custodian or with a designated sub-custodian. Mortgage and Asset-Backed Securities Subject to the approval of the Board of Trustees of the FUND, the FUND may invest in foreign mortgage-backed and asset-backed securities. The FUND will only purchase mortgage-backed and asset-backed securities which, in its opinion, equate generally to U.S. standards of "investment grade" obligations. -11- Mortgage-backed securities are securities that directly or indirectly represent a participation in, or are secured by and payable from, mortgage loans on real property, including pass-through securities and collateralized mortgage obligations. The yield and credit characteristics of mortgage-backed securities differ in a number of respects from traditional debt securities. Asset-backed securities have similar structural characteristics to mortgage-backed securities. However, the underlying assets are not mortgage loans or interests in mortgage loans but include assets such as motor vehicle installment sales or installment loan contracts, leases of various types of real and personal property, and receivables from revolving credit (credit card) agreements. Forward Foreign Currency Exchange Contracts The value of the FUND's assets as measured in U.S. dollars may be affected favorably or unfavorably by changes in foreign currency exchange rates and exchange control regulations, and the FUND may incur costs in connection with conversions between various currencies. The FUND may purchase or sell forward foreign currency exchange contracts ("forward contracts") to attempt to minimize the risk to the FUND from adverse changes in the relationship between the U.S. dollar and foreign currencies. A forward contract is an obligation to purchase or sell a specific currency for an agreed price at a future date which is individually negotiated and privately traded by currency traders and their customers. The FUND may enter into a forward contract, for example, when it enters into a contract for the purchase or sale of a security denominated in a foreign currency in order to "lock in" the U.S. dollar price of the security ("transaction hedge"). Additionally, for example, when the FUND believes that a foreign currency may suffer a substantial decline against the U.S. dollar, it may enter into a forward sale contract to sell an amount of that foreign currency approximating the value of some or all of the FUND's securities denominated in such foreign currency, or when the FUND believes that the U.S. dollar may suffer a substantial decline against foreign currency, it may enter into a forward purchase contract to buy that foreign currency for a fixed dollar amount ("position hedge"). In this situation, the FUND may, in the alternative, enter into a forward contract to sell a different foreign currency for a fixed U.S. dollar amount where it believes that the U.S. dollar value of the currency to be sold pursuant to the forward contract will fall whenever there is a decline in the U.S. dollar value of the currency in which portfolio securities of the sector are denominated ("cross-hedge"). If the FUND enters into a position hedging transaction, cash not available for investment or U.S. Government Securities or other high quality debt securities will be placed in a segregated account in an amount sufficient to cover the FUND's net liability under such hedging transactions. If the value of the securities placed in the segregated account declines, additional cash or securities will be placed in the account so that the value of the account will equal the amount of the FUND's commitment with respect to its position hedging transactions. As an alternative to maintaining all or part of the separate account, the FUND may purchase a call option permitting it to purchase the amount of foreign currency being hedged by a forward sale contract at a price no higher than the forward contract price or the FUND may purchase a put option permitting it to sell the amount of foreign currency subject to a forward purchase contract at a price as high or higher than the forward contract price. Unanticipated changes in currency prices would result in lower overall performance for the FUND than if it had not entered into such contracts. While the pursuit of foreign currency gain is not a primary objective of the FUND, the FUND may, from time to time, hold foreign currency to realize such gains. (These gains may constitute non-qualifying income that is subject to the 10% limitation with respect to the "Income Requirements" of Subchapter M of the Internal Revenue Code of 1986, as amended, which is discussed herein under "Dividends, Capital Gains Distributions and Tax Matters".) -12- The FUND will enter into forward foreign currency exchange contracts as described hereafter. When the FUND enters into a contract for the purchase or sale of a security denominated in a foreign currency, it may desire to establish the U.S. dollar cost or proceeds. By entering into a forward contract in U.S. dollars for the purchase or sale of the amount of foreign currency involved in an underlying security transaction, the FUND will be able to protect itself against a possible loss between trade and settlement dates resulting from an adverse change in the relationship between the U.S. dollar and such foreign currency. However, this tends to limit potential gains which might result from a positive change in such currency relationships. When a Portfolio Adviser believes that the currency of a particular foreign country may suffer a substantial decline against the U.S. dollar, it may enter into a forward contract to sell an amount of foreign currency approximating the value of some or all of the FUND's portfolio securities denominated in such foreign currency. The forecasting of short-term currency market movement is extremely difficult and the successful execution of a short-term hedging strategy is highly uncertain. Under normal circumstances, consideration of the prospect for currency parities will be incorporated into the longer term investment decisions made with regard to overall strategies. However, the Trustees of the FUND believe that it is important to have the flexibility to enter into such forward contracts when a Portfolio Adviser determines that the best interests of the FUND will be served. Generally, the FUND will not enter into a forward foreign currency exchange contract with a term of greater than one year. At the maturity of the contract, the FUND may either sell the portfolio security and make delivery of the foreign currency, or may retain the security and terminate the obligation to deliver the foreign currency by purchasing an "offsetting" forward contract with the same currency trader obligating the FUND to purchase, on the same maturity date, the same amount of foreign currency. It is impossible to forecast with absolute precision the market value of portfolio securities at the expiration of the contract. Accordingly, it may be necessary for the FUND to purchase additional foreign currency on the spot market (and bear the expense of such purchase) if the market value of the security is less than the amount of foreign currency the FUND is obligated to deliver and if a decision is made to sell the security and make delivery of the foreign currency. Conversely, it may be necessary to sell on the spot market some of the foreign currency received upon the sale of the portfolio security if its market value exceeds the amount of foreign currency the FUND is obligated to deliver. If the FUND retains the portfolio security and engages in an offsetting transaction, the FUND will incur a gain or a loss (as described below) to the extent that there has been movement in forward contract prices. If the FUND engages in an offsetting transaction, it may subsequently enter into a new forward contract to sell the foreign currency. Should forward prices decline during the period between entering into a forward contract for the sale of a foreign currency and the date the FUND enters into an offsetting contract for the purchase of the foreign currency, the FUND will realize a gain to the extent the price of the currency the FUND has agreed to sell exceeds the price of the currency it has agreed to purchase. Should forward prices increase, the FUND will suffer a loss to the extent the price of the currency the FUND has agreed to purchase exceeds the price of the currency the FUND has agreed to sell. The FUND's dealing in forward foreign currency exchange contracts will be limited to the transactions described above. Of course, the FUND is not required to enter into such transactions with regard to its foreign currency-denominated securities and will not do so unless deemed appropriate by the Portfolio Adviser. It also should be realized that this method of protecting the value of the FUND's portfolio securities against the decline in the value of a currency does not eliminate fluctuations in the underlying prices of the securities. It simply establishes a rate of exchange which one can achieve at some future point in time. -13- Additionally, although such contracts tend to minimize the risk of loss due to a decline in the value of the hedged currency, at the same time they tend to limit any potential gain which might result should the value of such currency increase. Additional Risks of Futures Contracts and Related Options, Forward Foreign Currency Exchange Contracts and Options on Foreign Currencies The market prices of futures contracts may be affected by certain factors. First, all participants in the futures market are subject to margin deposit and maintenance requirements. Rather than meeting additional margin deposit requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the securities and futures markets. Second, from the point of view of speculators, the deposit requirements in the futures market are less onerous than margin requirements in the securities market. Therefore, increased participation by speculators in the futures market may also cause temporary price distortions. In addition, futures contracts in which the FUND may invest may be subject to commodity exchange imposed limitations on fluctuations in futures contract prices during a single day. Such regulations are referred to as "daily price fluctuation limits" or "daily limits." During a single trading day no trades may be executed at prices beyond the daily limit. Once the price of a futures contract has increased or decreased by an amount equal to the daily limit, positions in those futures cannot be taken or liquidated unless both a buyer and seller are willing to effect trades at or within the limit. Daily limits, or regulatory intervention in the commodity markets, could prevent the FUND from promptly liquidating unfavorable positions and adversely affect operations and profitability. Options on foreign currencies and forward foreign currency exchange contracts ("forward contracts") are not traded on contract markets regulated by the Commodity Futures Trading Commission ("CFTC") and are not regulated by the SEC. Rather, forward currency contracts are traded through financial institutions acting as market-makers. Foreign currency options are traded on certain national securities exchanges, such as the Philadelphia Stock Exchange and the Chicago Board Options Exchange, subject to SEC regulation. In the forward currency market, there are no daily price fluctuation limits, and adverse market movements could therefore continue to an unlimited extent over a period of time. Moreover, a trader of forward contracts could lose amounts substantially in excess of its initial investments, due to the collateral requirements associated with such positions. Options on foreign currencies traded on national securities exchanges are within the jurisdiction of the SEC, as are other securities traded on such exchanges. As a result, many of the protections provided to traders on organized exchanges will be available with respect to such transactions. In particular, all foreign currency option positions entered into on a national securities exchange are cleared and guaranteed by the OCC, thereby reducing the risk of counterparty default. Further, a liquid secondary market in options traded on a national securities exchange may exist, potentially permitting the FUND to liquidate open positions at a profit prior to exercise or expiration, or to limit losses in the event of adverse market movements. The purchase and sale of exchange-traded foreign currency options, however, are subject to the risks of the availability of a liquid secondary market described above, as well as the risks regarding adverse market movements, margining of options written, the nature of the foreign currency market, possible intervention by governmental authorities and the effects of other political and economic events. In addition, exercise and settlement of such options must be made exclusively through the OCC, which has established banking relationships in applicable foreign countries for this purpose. As a result, the OCC may, if it -14- determines that foreign governmental restrictions or taxes would prevent the orderly settlement of foreign currency option exercises, or would result in undue burdens on the OCC or its clearing member, impose special procedures on exercise and settlement, such as technical changes in the mechanics of delivery of currency, the fixing of dollar settlement prices or prohibitions on exercise. In addition, futures contracts and related options and forward contracts and options on foreign currencies may be traded on foreign exchanges, to the extent permitted by the CFTC. Such transactions are subject to the risk of governmental actions affecting trading in or the prices of foreign currencies or securities. The value of such positions also could be adversely affected by (a) other complex foreign political and economic factors, (b) lesser availability than in the United States of data on which to make trading decisions, (c) delays in the FUND's ability to act upon economic events occurring in foreign markets during nonbusiness hours in the United States and the United Kingdom, (d) the imposition of different exercise and settlement terms and procedures and margin requirements than in the United States, and (e) lesser trading volume. Regulatory Matters In connection with its proposed futures and options transactions, the FUND will file with the Commodity Futures Trading Commission ("CFTC") a notice of eligibility for exemption from the definition of (and therefore from CFTC regulation as) a "commodity pool operator" under the Commodity Exchange Act. The FUND may engage in futures and options transactions only to the extent permitted by the CFTC and the Securities and Exchange Commission ("SEC"). The Staff of the SEC has taken the position that the purchase and sale of futures contracts and the writing of related options may involve senior securities for the purposes of the restrictions contained in Section 18 of the Investment Company Act of 1940 on investment companies issuing senior securities. However, the Staff has issued letters declaring that it will not recommend enforcement action under Section 18 if an investment company: (i) sells futures contracts to offset expected declines in the value of the investment company's portfolio securities, provided the value of such futures contracts does not exceed the total market value of those securities (plus such additional amount as may be necessary because of differences in the volatility factor of the portfolio securities vis a vis the futures contracts); (ii) writes call options on futures contracts, stock indexes or other securities, provided that such options are covered by the investment company's holding of a corresponding long futures position, by its ownership of portfolio securities which correlate with the underlying stock index, or otherwise; (iii) purchases futures contracts, provided the investment company establishes a segregated account ("cash segregated account") consisting of cash or cash equivalents in an amount equal to the total market value of such futures contracts less the initial margin deposited therefor; and (iv) writes put options on futures contracts, stock indices or other securities, provided that such options are covered by the investment company's holding of a corresponding short futures position, by establishing a cash segregated -15- account in an amount equal to the value of its obligation under the option, or otherwise. The FUND will conduct its purchases and sales of futures contracts and writing of related options transactions in accordance with the foregoing. Repurchase Agreements The FUND may enter into repurchase agreements. Under a repurchase agreement, the FUND acquires a debt instrument for a relatively short period (usually not more than one week) subject to the obligation of the seller to repurchase and the FUND to resell such debt instrument at a fixed price. The resale price is in excess of the purchase price in that it reflects an agreed-upon market interest rate effective for the period of time during which the FUND's money is invested. The FUND's risk is limited to the ability of the seller to pay the agreed-upon sum upon the delivery date. When the FUND enters into a repurchase agreement, it obtains collateral having a value at least equal to the amount of the purchase price. Repurchase agreements can be considered loans as defined by the 1940 Act, collateralized by the underlying securities. The return on the collateral may be more or less than that from the repurchase agreement. The securities underlying a repurchase agreement will be marked to market every business day so that the value of the collateral is at least equal to the value of the loan, including the accrued interest earned. In evaluating whether to enter into a repurchase agreement, VCM will carefully consider the creditworthiness of the seller. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the FUND may incur a loss. Illiquid Securities The FUND has adopted the following investment policy, which may be changed by the vote of the Board of Trustees. The FUND will not invest in illiquid securities if immediately after such investment more than 15% of the FUND's total assets (taken at market value) would be invested in such securities. For this purpose, illiquid securities include (a) securities that are illiquid by virtue of the absence of a readily available market or legal or contractual restrictions on resale, (b) participation interests in loans that are not subject to puts, (c) covered call options on portfolio securities written by the FUND over-the-counter and the cover for such options and (d) repurchase agreements not terminable within seven days. Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended ("Securities Act"), securities that are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities that have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient -16- institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. The FUND may invest up to 15% of its total assets in restricted securities issued under Section 4(2) of the Securities Act, which exempts from registration "transactions by an issuer not involving any public offering". Section 4(2) instruments are restricted in the sense that they can only be resold through the issuing dealer and only to institutional investors; they cannot be resold to the general public without registration. The Commission has adopted Rule 144A, which allows a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act applicable to resales of certain securities to qualified institutional buyers. FUND management anticipates that the market for certain restricted securities such as institutional commercial paper will expand further as a result of this new regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (the "NASD"). FUND management will monitor the liquidity of restricted securities in the FUND's portfolio under the supervision of the FUND's Trustees. In reaching liquidity decision, FUND management will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) 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 the transfer). RISK FACTORS AND SPECIAL CONSIDERATIONS Lower Quality Fixed Income Securities. The FUND may invest up to 35% of its assets in lower quality fixed income securities. The lower quality fixed income securities that may comprise all of the fixed income sector's investments generally produce a higher current yield than do fixed income securities of higher quality. However, these high risk/high return securities are considered speculative because they involve greater price volatility and risk than do higher quality fixed income securities and yields on these fixed income securities will tend to fluctuate over time. Although the market value of all fixed income securities varies as a result of changes in prevailing interest rates (e.g., when interest rates rise, the market value of fixed income securities can be expected to decline), values of lower quality fixed income securities tend to react differently than the values of higher quality fixed income securities. The prices of lower quality fixed income securities are less sensitive to changes in interest rates than higher quality fixed income securities. Conversely, lower quality fixed income securities also involve a greater risk of default by the issuer in the payment of principal and income and are more sensitive to economic downturns and recessions than higher quality fixed income securities. The financial stress resulting from an economic downturn could have a greater negative effect on the ability of issuers of lower quality fixed income securities to service their principal and interest payments, to meet projected business goals and to obtain additional financing than on more creditworthy issuers. In the event of an issuer's default in payment of principal or interest on such securities, or any other fixed income securities in the FUND's portfolio, the net asset value of the FUND will be negatively affected. Moreover, as the market for lower quality fixed income -17- securities is a relatively new one, a severe economic downturn might increase the number of defaults, thereby adversely affecting the value of all outstanding lower quality fixed income securities and disrupting the market for such securities. Fixed income securities purchased by the FUND as part of an initial underwriting present an additional risk due to their lack of market history. These risks are exacerbated with respect to fixed income securities rated Caa or lower by Moody's or CCC or lower by S&P. Unrated fixed income securities generally carry the same risks as do lower rated fixed income securities. Lower quality fixed income securities are typically traded among a smaller number of broker- dealers rather than in a broad secondary market. Purchasers of lower quality fixed income securities tend to be institutions, rather than individuals, a factor that further limits the secondary market. To the extent that no established retail secondary market exists, many lower quality fixed income securities may not be as liquid as Treasury and investment grade bonds. The ability of the FUND to sell lower quality fixed income securities will be adversely affected to the extent that such securities are thinly traded or illiquid. Moreover, the ability of the FUND to value lower quality fixed income securities becomes more difficult, and judgment plays a greater role in valuation, as there is less reliable, objective data available with respect to such securities that are thinly traded or illiquid. Unrated fixed income securities are not necessarily of lower quality than rated fixed income securities, but they may not be attractive to as many buyers. Because investors may perceive that there are greater risks associated with the lower quality fixed income securities of the type in which the FUND may invest, the yields and prices of such securities may tend to fluctuate more than those for lower quality fixed income securities. Changes in perception of issuers' creditworthiness tend to occur more frequently and in a more pronounced manner in the lower quality segments of the fixed income securities market than do changes in higher quality segments of the fixed income securities market, resulting in greater yield and price volatility. The speculative characteristics of lower rated fixed income securities are set forth in Appendix A. OFFITBANK believes that the risks of investing in such high yielding, fixed income securities may be minimized through careful analysis of prospective issuers. Although the opinion of ratings services such as Moody's and S&P is considered in selecting portfolio securities, they evaluate the safety of the principal and the interest payments of the security, not their market value risk. Additionally, credit rating agencies may experience slight delays in updating ratings to reflect current events. OFFITBANK relies, primarily, on its own credit analysis. This may suggest, however, that the achievement of one portion of the FUND's investment objective is more dependent on OFFITBANK's proprietary credit analysis, than is otherwise the case for a fund that invests exclusively in higher quality fixed income securities. Once the rating of a portfolio security or the quality determination ascribed by OFFITBANK to an unrated fixed income security has been downgraded, OFFITBANK will consider all circumstances deemed relevant in determining whether to continue to hold the security. Investors should recognize that investing in securities of companies in emerging countries involves certain special considerations and risk factors, including those set forth below, which are not typically associated with investing in securities of U.S. companies. Foreign Currency Considerations The FUND's assets will be invested principally in securities of entities in emerging markets and substantially all of the income received by the FUND will be in foreign currencies. However, the FUND will compute and distribute its income in U.S. dollars, and the computation of income will be made on the date -18- that the income is earned by the FUND at the foreign exchange rate in effect on that date. Therefore, if the value of the foreign currencies in which the FUND receives its income falls relative to the U.S. dollar between the earning of the income and the time at which the FUND converts the foreign currencies to U.S. dollars, the FUND will be required to liquidate securities in order to make distributions if the FUND has insufficient cash in U.S. dollars to meet distribution requirements. The liquidation of investments, if required, may have an adverse impact on the FUND's performance. In addition, if the liquidated investments include securities that have been held less than three months, such sales may jeopardize the FUND's status as a regulated investment company under the Code. See "Tax Matters". Since the FUND will invest in securities denominated or quoted in currencies other than the U.S. dollar, changes in foreign currency exchange rates will affect the value of securities in the FUND's portfolio and the unrealized appreciation or depreciation of investments. Further, the FUND may incur costs in connection with conversions between various currencies. Foreign exchange dealers realize a profit based on the difference between the prices at which they are buying and selling various currencies. Thus, a dealer normally will offer to sell a foreign currency to the FUND at one rate, while offering a lesser rate of exchange should the FUND desire immediately to resell that currency to the dealer. The 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 entering into forward, futures or options contracts to purchase or sell foreign currencies. The FUND may seek to protect the value of some portion or all of its portfolio holdings against currency risks by engaging in hedging transactions. The FUND may enter into forward currency exchange contracts and currency futures contracts and options on such futures contracts, as well as purchase put or call options on currencies, in U.S. or foreign markets. In order to hedge against adverse market shifts, the FUND may purchase put and call options on stocks, write covered call options on stocks and enter into stock index futures contracts and related options. There can be no guarantee that instruments suitable for hedging currency or market shifts will be available at the time when the FUND wishes to use them. Moreover, investors should be aware that in most emerging countries the markets for certain of these hedging instruments are not highly developed and that in many emerging countries no such markets currently exist. Investment and Repatriation Restrictions Some emerging market countries have laws and regulations that currently preclude direct foreign investment in the securities of their companies. However, indirect foreign investment in the securities of companies listed and traded on the stock exchange in these countries is permitted by certain emerging market countries through investment funds which have been specifically authorized. The FUND may invest in these investment funds subject to the provisions of the 1940 Act. If the FUND invests in such investment funds, the FUND's shareholders will bear not only their proportionate share of the expenses of the FUND (including operating expenses and the fees of VCM), but also will indirectly bear similar expenses of the underlying investment funds. See also "Tax Matters" for a discussion of passive foreign investment companies. In addition, prior governmental approval for foreign investments may be required under certain circumstances in some emerging market countries, and the extent of foreign investment in 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 market countries to prevent, among other concerns, violation of foreign investment limitations. -19- Repatriation of investment income, capital and the proceeds of sales by foreign investors may require governmental registration and/or approval in some emerging market countries. The FUND could be adversely affected by delays in or a refusal to grant any required governmental registration or approval for such repatriation or by withholding taxes imposed by emerging market countries on interest or dividends paid on securities held by the FUND or gains from the disposition of such securities. See "Tax Matters". Emerging Market Securities Markets Trading volume in emerging market securities markets is substantially less than that in the United States. Further, securities of some emerging market country companies are less liquid and more volatile than securities of comparable U.S. companies. Commissions for trading on emerging market country stock exchanges are generally higher than commissions for trading on U.S. exchanges, although the Portfolio Adviser will endeavor to achieve the most favorable net results on the FUND's portfolio transactions and may, in certain instances, be able to purchase its portfolio investments on other stock exchanges where commissions are negotiable. Companies in emerging market countries are not generally subject to uniform accounting, auditing and financial reporting standards, practices and disclosure requirements comparable to those applicable to U.S. companies. Consequently, there may be less publicly available information about an emerging market country company than about a U.S. company. Further, there is generally less government supervision and regulation of foreign stock exchanges, brokers and listed companies than in the United States. Investments in Unlisted Securities Although the Fund expects to invest primarily in listed securities, it may invest up to 15% of its total assets in the aggregate in unlisted Emerging Market Equity Securities, including investments in new and early stage companies, which may involve a high degree of business and financial risk that can result in substantial losses. Because of the absence of any trading market for these investments, the FUND may take longer to liquidate these positions than would be the case for publicly traded securities. Although these securities may be resold in privately negotiated transactions, the prices realized on these sales could be less than those originally paid by the FUND. Further, companies whose securities are not publicly traded may not be subject to public disclosure and other investor protection requirements applicable to publicly traded securities. Economic and Political Risks The economies of individual emerging market 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 upon 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. With respect to any emerging market country, there is the possibility of nationalization, expropriation or confiscatory taxation, political changes, government regulation, social instability or diplomatic developments (including war) which could affect adversely the economies of such countries or the value of the -20- FUND's investment in those countries. In addition, it may be difficult to obtain and enforce a judgment in a court outside of the United States. Portfolio Turnover Generally, the FUND's portfolio turnover rate is not expected to exceed 100%. A 100% portfolio turnover rate would occur if 100% of the securities owned by the FUND were sold and either repurchased or replaced by it within one year. The FUND's portfolio turnover rate is, generally, the percentage computed by dividing the lesser of FUND's purchases or sales exclusive of short-term securities, by the average value of the FUND's total investments exclusive of short-term securities. High portfolio turnover involves correspondingly greater brokerage commissions, other transaction costs, and a possible increase in short-term capital gains or losses. Shareholders are taxed on any such net gains at ordinary income rates. Because any capital gains realized would be distributed to shareholders at year-end, shareholders should consider the impact of such distributions on their own tax position. For the period March 1, 1994 (commencement of operations) to April 30, 1994 and the fiscal year ended April 30, 1995, the Funds portfolio turnover rates were 0% and 132%, respectively. INVESTMENT RESTRICTIONS Investment restrictions are fundamental policies and cannot be changed without approval of the holders of a majority (as defined in the 1940 Act) of the outstanding shares of the FUND. As used in the Prospectus and the Statement of Additional Information, the term "majority of the outstanding shares" of the FUND means, respectively, the vote of the lesser of (i) 67% or more of the shares of the FUND present at a meeting, if the holders of more than 50% of the outstanding shares of the FUND are present or represented by proxy, or (ii) more than 50% of the outstanding shares of the FUND. The following are the FUND's investment restrictions set forth in their entirety. The FUND may not: 1. Purchase securities on margin, except such short-term credits as may be necessary for clearance of transactions and the maintenance of margin with respect to futures contracts. 2. Make short sales of securities or maintain a short position (except that the FUND may maintain short positions in foreign currency contracts, options and futures contracts). 3. Issue senior securities, except that the FUND may borrow up to 33 1/3% of the value of its total assets from a lender (i) to increase its holdings of portfolio securities, (ii) to meet redemption requests, or (iii) for such short-term credits as may be necessary for the clearance or settlement of the transactions. The FUND may pledge its assets to secure such borrowings. 4. Invest 25% or more of the total value of its assets in a particular industry, except that this restriction shall not apply to U.S. Government Securities. 5. Make any investment for the purpose of exercising control or management. 6. Buy or sell commodities or commodity contracts or real estate or interests in real estate, except that it may purchase and sell futures contracts on stock indices and foreign currencies, securities which are secured by real estate or commodities, and securities of companies which invest or deal in real estate or commodities. -21- 7. Make loans, except through repurchase agreements collateralized by the underlying securities. The securities underlying a repurchase agreement will be marked to market every business day and the value of the collateral will be at least equal to the value of the loan, including the accrued interest earned. 8. Act as an underwriter except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under applicable securities laws. 9. Purchase or otherwise acquire the securities of any investment company (except in connection with a merger, consolidation, acquisition of substantially all of the assets or reorganization of another investment company) if, as a result, the FUND and all of its affiliates would own more than 3% of the total outstanding stock of that company. 10. Purchase or retain securities of any issuer (other than the shares of the FUND) if to the FUND's knowledge, those officers and Trustees of the FUND and the officers and directors of VCM, who individually own beneficially more than 1/2 of 1% of the outstanding securities of such issuer, together own beneficially more than 5% of such outstanding securities. 11. Invest directly in oil, gas or other mineral exploration or development programs or leases; provided, however, that if consistent with the objective of the FUND, the FUND may purchase securities of issuers whose principal business activities fall within such areas. In order to permit the sale of shares of the FUND in certain states, the FUND may make commitments more restrictive than the restrictions described above. Should the FUND determine that any such commitment is no longer in the best interests of the FUND and its shareholders it will revoke the commitment by terminating sales of its shares in the state(s) involved. As a condition to the sale of its shares in the state of Texas, the Fund will not invest in warrants valued at the lower of cost or market, in excess of 5% of the value of the Fund's net assets, and no more than 2% of such value may be warrants which are not listed on the New York or American Stock Exchanges. Percentage restrictions apply at the time of acquisition and any subsequent change in percentages due to changes in market value of portfolio securities or other changes in total assets will not be considered a violation of such restrictions. PORTFOLIO TRANSACTIONS All orders for the purchase or sale of portfolio securities are placed on behalf of the FUND by the Portfolio Advisers subject to the supervision of VCM and the Trustees and pursuant to authority contained in the Investment Advisory Contract between the FUND and VCM, and the Sub-Advisory Agreements between VCM and the Portfolio Advisers. In selecting such brokers or dealers, each Portfolio Adviser will consider various relevant factors, including, but not limited to the best net price available, the size and type of the transaction, the nature and character of the markets for the security to be purchased or sold, the execution efficiency, settlement capability, financial condition of the broker-dealer firm, the broker-dealer's execution services rendered on a continuing basis and the reasonableness of any commissions. In addition to meeting the primary requirements of execution and price, brokers or dealers may be selected who provide research services, or statistical material or other services to the FUND or to a Portfolio Adviser for the FUND's use, which in the opinion of the Trustees, are reasonable and necessary to the FUND's normal operations. Those services may include economic studies, industry studies, security analysis or reports, sales literature and statistical services furnished either directly to the FUND or to a Portfolio Adviser. Such -22- allocation shall be in such amounts as VCM shall determine and each Portfolio Adviser shall report regularly to VCM who will in turn report to the Trustees on the allocation of brokerage for such services. The receipt of research from broker-dealers may be useful to a Portfolio Adviser in rendering investment management services to its other clients, and conversely, such information provided by brokers or dealers who have executed orders on behalf of the Portfolio Adviser's other clients may be useful to the Portfolio Adviser in carrying out its obligations to the FUND. The receipt of such research may not reduce the Portfolio Adviser's normal independent research activities. Each Portfolio Adviser is authorized, subject to best price and execution, to place portfolio transactions with brokerage firms that have provided assistance in the distribution of shares of the FUND and are authorized to use Federated Securities Corp. (the "Distributor"), and the Portfolio Adviser or an affiliated broker-dealer on an agency basis, to effect a substantial amount of the portfolio transactions which are executed on the New York or American Stock Exchanges, Regional Exchanges and Foreign Exchanges where relevant, or which are traded in the Over-the-Counter market. Any profits resulting from brokerage commissions earned by the Distributor as a result of FUND transactions will accrue to the benefit of the shareholders of the Distributor who are also shareholders of VCM. The Investment Advisory Contract does not provide for any reduction in the management fee as a result of profits resulting from brokerage commissions effected through the Distributor. In addition, each Sub-Advisory Agreement between VCM and a Portfolio Adviser does not provide for any reduction in the advisory fees as a result of profits resulting from brokerage commissions effected through the Portfolio Adviser or an affiliated brokerage firm. The Trustees had adopted certain procedures incorporating the standards of Rule 17e-1 issued under the 1940 Act which requires that the commissions paid the Distributor or to each Portfolio Manager or an affiliated broker-dealer must be "reasonable and fair compared to the commission, fee or other remuneration received or to be received by other brokers in connection with comparable transactions involving similar securities during a comparable period of time". The Rule and the procedures also contain review requirements and require VCM to furnish reports to the Trustees and to maintain records in connection with such reviews. Brokers or dealers who execute portfolio transactions on behalf of the FUND may receive commissions which are in excess of the amount of commissions which other brokers or dealers would have charged for effecting such transactions; provided, VCM determines in good faith that such commissions are reasonable in relation to the value of the brokerage and/or research services provided by such executing brokers or dealers viewed in terms of a particular transaction or VCM's overall responsibilities to the FUND. For the period March 1, 1994 (commencement of operations) to April 30, 1994 and the fiscal year ended April 30, 1995, the FUND incurred brokerage commission expenses of $4,763 and $139,224, respectively. It may happen that the same security will be held by other clients of VCM or of a Portfolio Adviser. When the other clients are simultaneously engaged in the purchase or sale of the same security, the prices and amounts will be allocated in accordance with a formula considered by VCM to be equitable to each, taking into consideration such factors as size of account, concentration of holdings, investment objectives, tax status, cash availability, purchase cost, holding period and other pertinent factors relative to each account. In some cases this system could have a detrimental effect on the price or volume of the security as far as the FUND is concerned. In other cases, however, the ability of the FUND to participate in volume transactions will produce better executions for the FUND. -23- COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The FUND will invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees. Portfolio securities of the FUND which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, currently 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the FUND. Money market instruments with less than sixty days remaining to maturity when acquired by the FUND will be valued on an amortized cost basis by the FUND, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the FUND acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Board determines during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders received by dealers prior to 4:15 P.M. (New York Time) will be confirmed at the previous offering price computed as of the close of trading on the options exchanges (normally 4:15 P.M., New York Time), provided the order is received by the FUND's Transfer Agent prior to 4:15 P.M. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 P.M. will be confirmed at the next computed offering price. -24- PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee which was in effect through December, 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions, for the one year period ended April 30, 1995 and for the life of the FUND (March 1, 1994 to April 30, 1995) were -19.80% and -17.44%, respectively. In addition to the total return quotations discussed above, the FUND may advertise its yield based on a 30-day (or one month) period ended on the date of the most recent balance sheet included in the -25- FUND's Post-Effective Amendment to its Registration Statement, computed by dividing the net investment income per share earned during the period by the maximum offering price per share on the last day of the period, according to the following formula: YIELD 2[(a-b +1)6-1] ------ cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. Under this formula, interest earned on debt obligations for purposes of "a" above, is calculated by (1) computing the yield to maturity of each obligation held by the FUND based on the market value of the obligation (including actual accrued interest) at the close of business on the last day of each month, or, with respect to obligations purchased during the month, the purchase price (plus actual accrued interest), (2) dividing that figure by 360 and multiplying the quotient by the market value of the obligation (including actual accrued interest as referred to above) to determine the interest income on the obligation for each day of the subsequent month that the obligation is in the FUND's portfolio (assuming a month of 30 days) and (3) computing the total of the interest earned on all debt obligations and all dividends accrued on all equity securities during the 30-day or one month period. In computing dividends accrued, dividend income is recognized by accruing 1/360 of the stated dividend rate of a security each day that the security is in the FUND's portfolio. For purposes of "b" above, Rule 12b-1 expenses are included among the expenses accrued for the period. Any amounts representing sales charges will not be included among these expenses; however, the FUND will disclose the pro rata share of the account opening fee. Undeclared earned income, computed in accordance with generally accepted accounting principles, may be subtracted from the maximum offering price calculation required pursuant to "d" above. Any quotation of performance stated in terms of yield will be given no greater prominence than the information prescribed under the Commission's rules. In addition, all advertisements containing performance data of any kind will include a legend disclosing that such performance data represents past performance and that the investment return and principal value of an investment will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. -26- The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a regulated investment company, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. Under the Code, gains or losses attributable to fluctuations in exchange rates which occur between the time the FUND accrues interest or other receivables or accrues expenses or other liabilities denominated in a foreign currency and the time the FUND actually collects such receivables or pays such liabilities are treated as ordinary income or ordinary loss. In addition to satisfying the Distribution Requirement, a regulated investment company must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the regulated investment company's principal business of investing in stock or securities) and other income (including but not limited to gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). However, foreign currency gains, including those derived from options, futures and forwards, will not in any event be characterized as Short-Short Gain if they are directly related to the regulated investment company's investments in stock or securities (or options or futures thereon). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated -27- securities that it has held for less than three months. However, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since the recognition of a loss before the expiration of the three-month holding period is disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months will not be treated as gross income derived from the sale or other disposition of such security within the meaning of the Short-Short Gain Test. However, income that is attributable to realized market appreciation will be treated as gross income from the sale or other disposition of securities for this purpose. In general, gain or loss recognized by the FUND on the disposition of an asset will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased by the FUND at a market discount (generally, at a price less than its principal amount) will be treated as ordinary income to the extent of the portion of the market discount which accrued while the FUND held the debt obligation. In addition, under the rules of Code Section 988, gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto (but only to the extent attributable to changes in foreign currency exchange rates), and gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, except for regulated futures contracts or non-equity options subject to Code Section 1256, will generally be treated as ordinary income or loss. In general, for purposes of determining whether capital gain or loss recognized by the FUND on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (1) the asset is used to close a "short sale" (which includes for certain purposes the acquisition of a put option) or is substantially identical to another asset so used, (2) the asset is otherwise held by the FUND as part of a "straddle" (which term generally excludes a situation where the asset is stock and the FUND grants a qualified covered call option (which, among other things, must not be deep-in-the-money) with respect thereto) or (3) the asset is stock and the FUND grants an in-the-money qualified covered call option with respect thereto. However, for purposes of the Short-Short Gain Test, the holding period of the asset disposed of may be reduced only in the case of clause (1) above. In addition, the FUND may be required to defer the recognition of a loss on the disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain recognized by the FUND on the lapse of, or any gain or loss recognized by the FUND from a closing transaction with respect to, an option written by the FUND will be treated as a short-term capital -28- gain or loss. For purposes of the Short-Short Gain Test, the holding period of an option written by the FUND will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the FUND may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Certain transactions that may be engaged in by the FUND (such as regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts) will be subject to special tax treatment as "Section 1256 contracts." Section 1256 contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated (by delivery, exercise, entering into a closing transaction or otherwise) as of such date. Any gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any other gain or loss that was previously recognized upon the termination of Section 1256 contracts during that taxable year. Any capital gain or loss for the taxable year with respect to Section 1256 contracts (including any capital gain or loss arising as a consequence of the year-end deemed sale of such contracts) is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The FUND, however, may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments of the FUND that are not Section 1256 contracts. The IRS has held in several private rulings (and Treasury Regulations now provide) that gains arising from Section 1256 contracts will be treated for purposes of the Short-Short Gain Test as being derived from securities held for not less than three months if the gains arise as a result of a constructive sale under Code Section 1256. The FUND may purchase securities of certain foreign investment funds or trusts which constitute passive foreign investment companies ("PFICs") for federal income tax purposes. If the FUND invests in a PFIC, it may elect to treat the PFIC as a qualifying electing fund (a "QEF") in which event the FUND will each year have ordinary income equal to its pro rata share of the PFIC's ordinary earnings for the year and long-term capital gain equal to its pro rata share of the PFIC's net capital gain for the year, regardless of whether the FUND receives distributions of any such ordinary earning or capital gain from the PFIC. If the FUND does not (because it is unable to, chooses not to or otherwise) elect to treat the PFIC as a QEF, then in general (1) any gain recognized by the FUND upon sale or other disposition of its interest in the PFIC or any "excess distribution" (as defined) received by the FUND from the PFIC will be allocated ratably over the FUND's holding period of its interest in the PFIC, (2) the portion of such gain or excess distribution so allocated to the year in which the gain is recognized or the excess distribution is received shall be included in the FUND's gross income for such year as ordinary income (and the distribution of such portion by the FUND to shareholders will be taxable as an ordinary income dividend, but such portion will not be subject to tax at the FUND level), (3) the FUND shall be liable for tax on the portions of such gain or excess distribution so allocated to prior years in an amount equal to, for each such prior year, (i) the amount of gain or excess distribution allocated to such prior year multiplied by the highest corporate tax rate in effect for such prior year plus (ii) interest on the amount determined under clause (i) for the period from the due date for filing a return for such prior year until the date for filing a return for the year in which the gain is recognized or the excess distribution is received at the rates and methods applicable to underpayments of tax for such period, and (4) the distribution by the FUND to shareholders of the portions of such gain or excess distribution so allocated to prior years (net of the tax payable by the FUND thereon) will again be taxable to the shareholders as an ordinary income dividend. Under recently proposed Treasury Regulations the FUND can elect to recognize as gain the excess, as of the last day of its taxable year, of the fair market value of each share of PFIC stock over the FUND's adjusted tax basis in that share ("mark to market gain"). Such mark to market gain will be included by the FUND as ordinary income, such gain will not be subject to the Short-Short Gain Test, and the FUND's -29- holding period with respect to such PFIC stock commences on the first day of the next taxable year. If the FUND makes such election in the first taxable year it holds PFIC stock, the FUND will include ordinary income from any mark to market gain, if any, and will not incur the tax described in the previous paragraph. However, until the proposed regulations are finalized, the application of the mark to market and related rules to the Fund is unclear. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it had been incurred in the succeeding year. As of April 30, 1995, the Fund elected to defer a net currency loss of $144,048 and a net capital loss of $2,474,894 incurred in fiscal 1995. In addition to satisfying the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of the FUND's taxable year, at least 50% of the value of the FUND's assets must consist of cash and cash items, U.S. Government securities, securities of other regulated investment companies, and securities of other issuers (as to which the FUND has not invested more than 5% of the value of the FUND's total assets in securities of such issuer and as to which the FUND does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other regulated investment companies), or in two or more issuers which the FUND controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security not the issuer of the option. However, with regard to forward currency contracts, there does not appear to be any formal or informal authority which identifies the issuer of such instrument. If for any taxable year the FUND does not qualify as a regulated investment company, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a regulated investment company that fails to distribute in each calendar year an amount equal to 98% of ordinary taxable income for the calendar year and 98% of capital gain net income for the one-year period ended on October 31 of such calendar year (or, at the election of a regulated investment company having a taxable year ending November 30 or December 31, for its taxable year (a "taxable year election")). The balance of such income must be distributed during the next calendar year. For the foregoing purposes, a regulated investment company is treated as having distributed any amount on which it is subject to income tax for any taxable year ending in such calendar year. For purposes of the excise tax, a regulated investment company shall: (1) reduce its capital gain net income (but not below its net capital gain) by the amount of any net ordinary loss for the calendar year; and (2) exclude foreign currency gains and losses incurred after October 31 of any year (or after the end of its taxable year if it has made a taxable year election) in determining the amount of ordinary taxable income for the -30- current calendar year (and, instead, include such gains and losses in determining ordinary taxable income for the succeeding calendar year). The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. However, investors should note that the FUND may in certain circumstances be required to liquidate portfolio investments to make sufficient distributions to avoid excise tax liability. FUND Distributions The FUND anticipates distributing substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but they generally should not qualify for the 70% dividends-received deduction for corporate shareholders. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute any such amounts. Net capital gain distributed and designated as a capital gain dividend will be taxable to shareholders as long-term capital gain, regardless of the length of time the shareholder has held his shares or whether such gain was recognized by the FUND prior to the date on which the shareholder acquired his shares. The Code provides, however, that under certain conditions only 50% of the capital gain recognized upon the FUND's disposition of "small business" stock will be subject to tax. Investment income that may be received by the FUND 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 which entitle the FUND to a reduced rate of, or exemption from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the amount of the FUND's assets to be invested in various countries is not known. If more than 50% of the value of the FUND's total assets at the close of its taxable year consist of the stock or securities of foreign corporations, the FUND may elect to "pass through" to the FUND's shareholders the amount of foreign taxes paid by the FUND. If the FUND so elects, each shareholder would be required to include in gross income, even though not actually received, his pro rata share of the foreign taxes paid by the FUND, but would be treated as having paid his pro rate share of such foreign taxes and would therefore be allowed to either deduct such amount in computing taxable income or use such amount (subject to various Code limitations) as a foreign tax credit against federal income tax (but not both). For purposes of the foreign tax credit limitation rules of the Code, each shareholder would treat as foreign source income his pro rata share of such foreign taxes plus the portion of dividends received from the FUND representing income derived from foreign sources. No deduction for foreign taxes could be claimed by an individual shareholder who does not itemize deductions. Each shareholder should consult his own tax adviser regarding the potential application of foreign tax credits. -31- Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholder's tax basis in his shares; any excess will be treated as gain from the sale of his shares, as discussed below. Distributions by the FUND will be treated in the manner described above regardless of whether such distributions are paid in cash or reinvested in additional shares of the FUND (or of another fund). Shareholders receiving a distribution in the form of additional shares will be treated as receiving a distribution in an amount equal to the fair market value of the shares received, determined as of the reinvestment date. In addition, if the net asset value at the time a shareholder purchases shares of the FUND reflects undistributed net investment income or recognized capital gain net income, or unrealized appreciation in the value of the assets of the FUND, distributions of such amounts will be taxable to the shareholder as dividends in the manner described above, although such distributions economically constitute a return of capital to the shareholder. Ordinarily, shareholders are required to take distributions by the FUND into account in the year in which the distributions are made. However, dividends declared in October, November or December of any year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such calendar year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of ordinary income dividends and capital gain dividends, and the proceeds of redemption of shares, paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all, (2) who is subject to backup withholding by the IRS for failure to report the receipt of interest or dividend income properly, or (3) who has failed to certify to the FUND that it is not subject to backup withholding or that it is a corporation or other "exempt recipient." Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of shares of the FUND in an amount equal to the difference between the proceeds of the sale or redemption and the shareholder's adjusted tax basis in the shares. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the sale or redemption. In general, any gain or loss arising from (or treated as arising from) the sale or redemption of shares of the FUND will be considered capital gain or loss and will be long-term capital gain or loss if the shares were held for longer than one year. However, any capital loss arising from the sale or redemption of shares held for six months or less will be treated as a long-term capital loss to the extent of the amount of capital gain dividends received on such shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) generally will apply in determining the holding period of shares. Long-term capital gains of noncorporate taxpayers are currently taxed at a maximum rate 11.6% lower than the maximum rate applicable to ordinary income. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income. -32- Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income from the FUND is "effectively connected" with a U.S. trade or business carried on by such shareholder. If the income from the FUND is not effectively connected with a U.S. trade or business carried on by a foreign shareholder, ordinary income dividends will be subject to U.S. withholding tax at the rate of 30% (or lower applicable treaty rate) upon the gross amount of the dividend. Furthermore, such a foreign shareholder may be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate) on the gross income resulting from the FUND's election to treat any foreign taxes paid by it as paid by its shareholders, but may not be allowed a deduction against this gross income or a credit against this U.S. withholding tax for the foreign shareholder's pro rata share of such foreign taxes which it is treated as having paid. Such a foreign shareholder would generally be exempt from U.S. federal income tax on gains realized on the sale of shares of the FUND, capital gain dividends. If the income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and any gains realized upon the sale of shares of the FUND will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless such shareholders furnish the FUND with proper notification of its foreign status. The tax consequences to a foreign shareholder entitled to claim the benefits of an applicable tax treaty may be different from those described herein. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations issued thereunder as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly change the conclusions expressed herein, and any such changes or decisions may have a retroactive effect with respect to the transactions contemplated herein. Rules of state and local taxation of ordinary income dividends and capital gain dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of these and other state and local tax rules affecting an investment in the FUND under their particular circumstances. -33- THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc., Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Asociates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc.
-34- William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center-Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region.
-35- Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner,
-36- Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities -37- Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.D. Government Securities Fund; 1-3 years; Federated U.S. Government Securities Fund; 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc.; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust; International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust/ Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II, Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Obligations; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of July 31, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of July 31, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND+ THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Truste $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trust $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex -38- James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds. MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. For the period from March 1, 1994 (commencement of operations) to April 30, 1994, the FUND's investment management fee paid to the prior manager was $9,452,.00 less voluntary expense reimbursement of $9,452.00. For the fiscal year ended April 30, 1995, the FUND's investment management fee paid to the prior manager was $174,720 less voluntary expense reimbursement of $90,297. -39- PORTFOLIO ADVISORY SERVICES Pursuant to sub-advisory agreements between VCM and Martin Currie, and between VCM and OFFITBANK (the "Sub-Advisory Agreements"), VCM, not the FUND, has agreed to pay Martin Currie a monthly fee at the annual rate of .50% of the first $150 million of the equity sector's average daily net assets and .40% of the sector's average daily net assets in excess of $150 million, and to pay OFFITBANK a monthly fee at the annual rate of .45% of the first $150 million of the fixed income sector's average daily net assets and .35% of the sector's average daily net assets in excess of $150 million. For the period March 1, 1994 (commencement of operations) to April 30, 1994 and the fiscal year ended April 30, 1995, the aggregate amounts paid by the prior manager to the sub-advisers were as follows: Martin Currie, Inc.: $1,740 and $59,427, respectively; and OFFITBANK: $0 and $2,703, respectively. Under the terms of each Sub-Advisory Agreement, the Portfolio Adviser has discretion to purchase and sell securities for the FUND, except as limited by the FUND's investment objective, policies and restrictions. Although each Portfolio Adviser's activities are subject to general oversight by VCM and the FUND's Board of Trustees, selection of specific securities in which the FUND may invest are made by the Portfolio Adviser. In carrying out its obligations, each Portfolio Adviser uses the same skill and care in providing such services as it uses in providing services to fiduciary accounts for which it has investment responsibilities; obtains and evaluates pertinent information about significant developments and economic, statistical and financial data, domestic, foreign or otherwise, whether affecting the economy generally or the FUND's portfolio and whether concerning the individual issuers whose securities are included in the FUND's portfolio or the activities in which the issuers engage, or with respect to securities which it considers desirable for inclusion in the FUND's portfolio; determines which issuers and securities shall be represented in the FUND's portfolio and regularly reports thereon to the FUND's Board of Trustees; fromulates and implements continuing programs for the purchases and sales of the securities of such issuers and regularly reports thereon to the FUND's Board of Trustees, as to deliveries of securities, transfers of currencies and payments of cash for the account of the FUND, in relation to the matters contemplated by the Sub-Advisory Agreement; and takes, on behalf of the FUND, all actions which appear to the FUND and VCM necessary to carry into effect such purchase and sale programs and supervisory functions as aforesaid, including the placing of orders for the purchase and sale of securities for the FUND and the prompt reporting to VCM of such purchases and sales. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Fund for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' particular circumstances and goals, and include, but are not limited to: providing office space, equipment, -40- 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. For the fiscal year ended April 30, 1995, the FUND accrued payments under the Plan amounting to $72,335. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. -41- The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. FINANCIAL STATEMENTS Audited financial statements for the fiscal year ended April 30, 1995 are attached hereto. -42- APPENDIX A Description of Moody's Investors Service, Inc.'s Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *Aaa: Bonds which are rated Aaa are judged to be 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 fluctuations 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: Bond which are rated A possess many favorable investment attributes and are to be considered as upper medium grade obligations. Factors giving security to principal and interest are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. *Baa: Bonds which are rated Baa are considered as medium grade obligations, i.e., they are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present, but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Ba: Bonds which are rated Ba are judged to have speculative elements; their future cannot be considered as well assured. Often the protection of interest and principal payments may be very moderate and thereby not well safeguarded during other good and bad times over the future. Uncertainty of position characterizes bonds in this class. B: Bonds which are rated B generally lack characteristics of the desirable investment. Assurance of interest and principal payments or of maintenance of other terms of the contract over any long period of time may be small. Caa: Bonds which are rated Caa are of poor standing. Such issues may be in default or there may be present elements of danger with respect to principal or interest. Ca: Bonds which are rated Ca represent obligations which are speculative in a high degree. Such issues are often in default or have other marked shortcomings. C: Bonds which are rated C are the lowest rated class of bonds and issues so rated can be regarded as having extremely poor prospects of ever attaining any real investment standing. A-1 Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic rating classification from Aa through B in its bond rating system. The modifier 1 indicates that the security ranks in the higher end of its generic rating category, the modifier 2 indicates a mid-range ranking, and the modifier 3 indicates that the issue ranks in the lower end of its generic rating category. Description of Moody's Commercial Paper Ratings: Moody's commercial paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Issuers rated Prime-1 or P-1 (or related supporting institutions) have a superior capacity for repayment of short-term promissory obligations. Prime-1 or P-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. Issuers rated Prime-2 or P-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 alternate liquidity is maintained. Description of Standard & Poor's Corporation's Bond Ratings: Investment grade debt securities are those rating categories indicated by an asterisk (*). *AAA: Debt rated AAA have the highest rating assigned by S&P to a debt obligation. capacity to pay interest and repay principal is extremely strong. *AA: Debt rated AA have a very strong capacity to pay interest; and repay principal and differ from the higher rated issues only in small degree. *A: Debt rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than bonds in higher rated categories. A-2 *BBB: Debt rated BBB are regarded as having an adequate capacity to pay interest and repay principal. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay interest and repay principal for bonds in this category than for bonds in higher rated categories. BB, B, CCC, CC, C: Debt rated "BB," "B," "CCC," "CC" and "C" is regarded, on balance, as predominantly speculative with respect to capacity to pay interest and repay principal in accordance with the terms of the obligation. "BB" indicates the lowest degree of speculation and "C" the highest degree of speculation. While such debt will likely have some quality and protective characteristics, these are outweighed by large uncertainties or major risk exposures to adverse conditions. BB: Debt rated "BB" has less near-term vulnerability to default than other speculative issues. However, it faces major ongoing uncertainties or exposure to adverse business, financial, or economic conditions which could lead to inadequate capacity to meet timely interest and principal payments. The "BB" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BBB-" rating. B: Debt rated "B" has a greater vulnerability to default but currently has the capacity to meet interest payments and principal repayments. Adverse business, financial or economic conditions will likely impair capacity or willingness to pay interest and repay principal. The "B" Rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "BB" or "BB-" rating. CCC: Debt rated "CCC" has a currently identifiable vulnerability to default, and is dependent upon favorable business, financial, and economic conditions to meet timely payment of interest and repayment of principal. In the event of adverse business, financial or economic conditions, it is not likely to have the capacity to pay interest and repay principal. The "C" rating category is also used for debt subordinated to senior debt that is assigned an actual or implied "B" or "B-" rating. CC: The rating "CC" is typically applied to debt subordinated to senior debt that is assigned an actual or implied "CCC" rating. C: The rating "C" is typically applied to debt subordinated to senior debt which is assigned an actual or implied "CCC-" debt rating. The "C" rating may be used to cover a situation where a bankruptcy petition has been filed, but debt service payments are continued. C1: The rating "C1" is reserved for income bonds on which no interest is being paid. D: Debt rated "D" is in payment default. The "D" rating category is used when interest payments or principal payments are not made on the date due even if the applicable grace period has not expired, unless S&P believes that such payments will be made during such grace period. The "D" rating also will be used upon the filing of a bankruptcy petition if debt service payments are jeopardized. Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the addition of a plus or minus sign to show relative standing within the major rating categories. NR: Bonds may lack a S&P rating because no public rating has been requested, because there is insufficient information on which to base a rating, or because S&P does not rate a particular type of obligation as a matter of policy. A-3 Description of S&P's Commercial Paper Ratings: S&P's commercial paper ratings are current assessments of the likelihood of timely payment of debts having an original maturity of no more than 365 days. A: Issues assigned this highest rating are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2 and 3 to indicate the relative degree of safety. A-1: This designation indicates that the degree of safety regarding timely payment is either overwhelming or very strong. Those issues determined to possess overwhelming safety characteristics are denoted with a plus (+) sign designation. A-2: Capacity for timely payment on issues with this designation is strong. However, the relative degree of safety is not as high as for issues designated "A-1". A-3: Issues carrying this designation have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. A-4 Dear Shareholders, Enclosed please find the Annual Report for your Blanchard Worldwide Emerging Markets Fund (formerly known as the Blanchard Emerging Markets Growth & Income Fund) for the fiscal year ending April 30, 1995. Since the launch of the Blanchard Worldwide Emerging Markets Fund, the returns available from global emerging markets have been generally disappointing and incredibly volatile. Fortunately, past performance is no indication of future performance. And indeed, the high volatility associated with the world's emerging markets has in other years led to significant returns for investors. That being said, here's a closer look at what happened in the emerging markets and your Blanchard Worldwide Emerging Markets Fund in fiscal 1994, as well as our outlook for fiscal 1995. The Year In Review The world's emerging markets were negatively affected by the change in the U.S. interest rate environment which began in early February 1994. The progressive tightening of U.S. monetary policy throughout the year significantly diminished the flow of U.S. investor dollars into emerging markets. The impact was initially felt in Asia, and as the year progressed, markets in Central Europe and Latin America also came under pressure. In addition to this diminished flow of U.S. investor dollars, a series of assassinations in Mexico, followed by the clumsy handling of the peso's devaluation in mid-December, caused the investment climate within Latin America to deteriorate rapidly. As a result, investors' perception of the risk inherent in South American investment dramatically increased and caused a sharp decline in most Latin American markets. As 1995 began, the world's emerging markets continued the volatile trend established in 1994. Latin America has experienced a roller-coaster ride, with The following information was reprint as a line graph. The Value of a $10,000 Investment in the Blanchard Worldwide Emerging Markets Fund from inception 3/1/94 through 4/30/95 as compared to Morgan Stanley Emerging Markets Index for the same period ----------------------------------------- Avg. Annual Returns through 4/30/95 Blanchard Worldwide Emerging Markets Fund* ----------------------------------------- 1 year -19.80% since inception -17.44% ----------------------------------------- FYE 4/30/94 FYE 4/30/95 BMBF -0.25% -19.80% MORGAN STANLEY -7.00% -4.78% BMBF $ 9,963 $9,938 $7,970 MORGAN STANLEY $10,000 $9,300 $8,855 Reflects deduction of $37.50 acct opening fee Blanchard Morgan Stanley Worldwide Emerging Emerging Markets Fund^ Markets Index(D) *Total return quoted above reflects reinvestment of distributions, but does not reflect the deduction of the one-time account opening fee. If deducted, return would be lower. Past performance is no guarantee of future results. (D)Source: Morgan Stanley Emerging Markets Index is an unmanaged index comprised of the average equity market performance of 20 emerging market countries throughout the world. ^Reflects deduction of one-time account opening fee of $37.50. This chart is for comparative purposes only and is not meant to reflect future performance of the Fund or the index. (over, please) both currencies and markets coming under significant pressure. This has led to a backlash of investor sentiment against emerging markets investing, affecting several markets in Asia, as well as Central Europe. Generally, investors' concerns have centered on countries where significant current account deficits have led to anxiety over currency values. The portfolio performance of your Blanchard Worldwide Emerging Markets Fund over the past year was negatively impacted by the high proportion of assets that were allocated to Latin America at the time of the Mexican devaluation. Ironically, our underweight position in these markets had affected overall returns in the summer, and the increased allocation to Latin America was in anticipation of what we believed would be a buoyant 1995! Investments in Poland and India also underperformed in 1994. A Look Ahead As 1995 has progressed, investor sentiment has gradually improved, faced with incredible valuation opportunities present in Latin America and, selectively, in Asia and Central Europe. Latin American markets, in particular, have bounced back almost to the levels at which they were standing in late December. The Fund's overweighted position in Peru has been of particular benefit to total returns. In other regions, the portfolio's position in Poland has benefited from a 50% run in the market since the end of March, and India has recovered nicely as well. Also, selective markets in South East Asia have begun to recover, and our weightings to markets like Thailand have proved rewarding. A word of caution, however: Confidence remains fragile, and with growth estimates being pared back in South America and selectively in Asia, overall returns are likely to continue to be difficult to achieve. However, there are some bright spots. First, the long-term trend for investment in these markets is well established and will continue for the foreseeable future; and second, valuations look significantly attractive in a number of the areas into which we are investing. Poland, for example, was selling for less than 6 times 1995 earnings before its recent recovery. In summary, provided that a long-term view is adopted, we believe it is still an excellent time to be investing in these rapidly developing markets where the potential exists for significant returns over time. Sincerely, JF:ml James Fairweather Martin Currie Inc. Portfolio Managers of the Blanchard Worldwide Emerging Markets Fund Distributed by Sheffield Investments, Inc. (1551) 08ARSL0695 BLANCHARD WORLDWIDE EMERGING MARKETS FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (Left Column) Shares Value ------ ----- EMERGING MARKETS SECURITIES (92.31%) ARGENTINA (3.50%) Consumer Goods & Related (1.83%) BAESA (ADR).............................. 5,600 $ 154,000 Quilmes Industrial S.A. (Regd)........... 3,600 68,400 ----------- 222,400 ----------- Utilities & Related (1.67%) Compania Naviera Perez Compac "B" Shares. 24,920 101,669 YPF Sociedad Anonima..................... 5,000 101,250 ----------- 202,919 ----------- TOTAL ARGENTINA.................... 425,319 ----------- BRAZIL (12.14%) Basic Industries (6.14%) Acesita PN (ADR)......................... 13,620 209,250 Compania Vale Do Rio Doce (ADR).......... 4,300 179,852 Usiminas (ADR)........................... 29,500 356,000 ----------- 745,102 ----------- Capital Goods (1.31%) (d)Rhodia Ster (GDR)........................ 11,687 158,986 ----------- Energy Related (1.54%) *Electrobras.............................. 451,000 124,414 *Electrobras "B" Shares................... 235,000 63,284 ----------- 187,698 ----------- Industrial Related (1.64%) *Cemig (ADS).............................. 8,541 199,584 ----------- Telecommunications (1.51%) Telebras (ADR)........................... 5,120 183,115 ----------- TOTAL BRAZIL....................... 1,474,485 ----------- CHILE (4.45%) Basic Industries (1.55%) Antofagasta Holding...................... 33,500 156,320 *Sociedad Quimica Y Minera (ADR).......... 900 31,388 ----------- 187,708 ----------- Capital Goods (2.39%) Madeco S.A. (ADR)........................ 6,000 174,750 Maderas Y Sinteticos Sociedad (ADS)...... 6,500 113,750 ----------- 288,500 ----------- Financial Services (.51%) Banco O'Higgins (ADS).................... 3,400 62,050 ----------- TOTAL CHILE........................ 538,258 ----------- CHINA (1.24%) Financial Services (1.24%) *China North Industries Investment Ltd........................... 150,000 150,000 ----------- COLOMBIA (3.09%) Basic Industries (2.13%) Cementos Diamante (GDS).................. 11,800 258,066 ----------- Financial Services (.96%) Banco Ganadero S.A. (GDR)................ 6,100 115,900 ----------- TOTAL COLOMBIA..................... 373,966 ----------- (Right Column) Shares Value ------ ----- ECUADOR (.50%) Construction (.50%) La Cemento Nacional de Ecuador (GDR)..... 256 $ 60,160 ----------- HONG KONG (3.30%) Banking (1.48%) Dao Heng Bank Group Ltd. ................ 70,000 179,047 ----------- Manufacturing (.29%) Champion Technology...................... 465,000 35,441 *Star Paging Int'l. Warrants 12/31/96..... 40,000 248 ----------- 35,689 ----------- Transportation & Shipping (1.53%) *Shanghai Haixing Shipping................ 1,000,000 186,022 ----------- TOTAL HONG KONG.................... 400,758 ----------- HUNGARY (1.52%) Capital Goods (.80%) *Matav Rt. ............................... 550 97,345 ----------- Consumer Goods & Related (.20%) *Kekkut Asvanyjz (GDR).................... 2,800 24,284 ----------- Financial Services (.26%) *Konzum (GDR)............................. 7,600 31,176 ----------- Telecommunications (.26%) *Hungarian Telephone & Cable Co. ......... 2,700 31,725 ----------- TOTAL HUNGARY...................... 184,530 ----------- INDIA (7.20%) Basic Industries (2.45%) Principal Gujarat Ambuja Cements Ltd. --------- Conv. Bd. 3.50%, 6/30/99............... $80,000 103,000 Shares ------ *Hindalco Industries Ltd. (GDR)........... 3,500 91,000 United Phosphorus (GDR).................. 4,300 104,275 ----------- 298,275 ----------- Consumer Goods & Related (1.38%) *DCW Ltd. (GDR)........................... 4,800 62,400 *Dr. Reddy's Laboratories (GDR)........... 10,000 105,000 ----------- 167,400 ----------- Investment Companies (3.37%) *Himalayan Fund........................... 7,803 106,901 *Himalayan Fund Bonus Wts. 12/31/96....... 1,180 738 *Indian Opportunities Fund Ltd............ 22,807 301,514 ----------- 409,153 ----------- TOTAL INDIA........................ 874,828 ----------- INDONESIA (2.74%) Banking (.79%) Bank Internasional Indonesia............. 41,000 95,477 ----------- Chemicals (.29%) *PT Keramika Indonesia Assoc. ............ 41,000 34,886 ----------- Capital Goods (.52%) *PT Argha Karya Prima..................... 12,000 8,598 PT Indosat (ADR)......................... 1,500 54,187 ----------- 62,785 ----------- 3 BLANCHARD WORLDWIDE EMERGING MARKETS FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) (Left column) Shares Value ------ ----- Consumer Goods & Related (1.14%) PT Andayani Megah........................ 34,000 $ 30,452 PT Concord Benefic Textile Co. .......... 39,000 77,721 *PT Kalbe Farma........................... 8,500 30,262 ----------- 138,435 ----------- TOTAL INDONESIA.................... 331,583 ----------- ISRAEL (.34%) Investment Companies (.23%) First Israel Fund........................ 2,300 27,600 ----------- Financial Services (.11%) *Ampal American Israel Cl. A ............. 2,200 14,025 ----------- TOTAL ISRAEL....................... 41,625 ----------- KOREA (8.87%) Basic Industries (.46%) Kumho Construction & Energy Co. Pfd. .... 8,000 56,142 ----------- Capital Goods (.83%) *Anam Industrial Co. Ltd. Pfd. ........... 4,000 50,318 *Dae Woo Heavy Industries Pfd. ........... 6,000 50,764 ----------- 101,082 ----------- Consumer Goods & Related (1.99%) *Midopa Co. .............................. 6,000 74,769 *Samsung Electronics Pfd. ................ 2,036 166,651 ----------- 241,420 ----------- Energy Related (.12%) Principal Ssangyong Oil Refining Co. --------- 3.00% 12/31/04 .................... $20,000 14,050 Shares ----------- Financial Services (1.69%) ------ *Commercial Bank of Korea................. 12,000 124,352 *Hanshin Securities Co. Pfd. ............. 3,000 37,975 *Jin Heung Svgs. & Finance................ 1,500 42,697 ----------- 205,024 ----------- Transportation (.34%) *Dong Bang Forwarding Co. ................ 1,000 40,795 ----------- Utilities & Related (3.44%) *Korea Electric Power Co. ................ 9,000 329,376 *Yukong Ltd. ............................. 2,000 88,673 ----------- 418,049 ----------- TOTAL KOREA........................ 1,076,562 ----------- LUXEMBOURG (1.23%) Telecommunications (1.23%) *Millicom International Cellular.......... 6,000 149,250 ----------- MALAYSIA (2.87%) Basic Industries (1.57%) Aokam Perdana Ltd. ...................... 42,400 190,465 ----------- Consumer Goods & Related (.41%) Edaran Otomobile Nasional................ 7,000 49,858 ----------- Financial Services (.89%) Westmont Berhard......................... 25,000 108,256 ----------- TOTAL MALAYSIA..................... 348,579 ----------- (Right column) Shares Value ------ ----- MEXICO (3.55%) Basic Industries (.51%) Kimberly Clark de Mexico (ADR)........... 3,000 $ 61,976 ----------- Financial Services (3.04%) *Ceteco (ADR)............................. 9,500 260,965 *Grupo Carso S.A. (ADR)................... 10,000 108,526 ----------- 369,491 ----------- TOTAL MEXICO....................... 431,467 ----------- PAKISTAN (.05%) Basic Industries (.05%) *D.G. Khan Cement Ltd. ................... 4,620 6,369 ----------- PERU (7.90%) Capital Goods (1.64%) Cementos Lima "C" Shares................. 7,800 172,908 Cementos Norte Pacasmayo................. 7,632 26,552 ----------- 199,460 ----------- Financial Services (1.84%) Banco Wiese (ADR)........................ 8,149 73,339 *Banco Wiese " C" Shares.................. 2 4 Banco de Credito del Peru................ 71,785 150,486 ----------- 223,829 ----------- Real Estate (2.36%) *Peru Real Estate S.A. "B" Shares.......... 345,000 286,350 ----------- Telecommunications (2.06%) *CIA Peruana de Telefonos "B" Shares....... 129,874 217,808 *La Neuva Com de Telefonos................. 39,756 32,273 ----------- 250,081 ----------- TOTAL PERU......................... 959,720 ----------- POLAND (4.26%) Capital Goods (1.21%) *Bydogoska Fabryka Kabli (PDR)............ 3,000 33,060 *Polifarb Ciezyn (PDR).................... 11,500 63,607 *T. C. Debica (PDR)....................... 4,000 50,666 ----------- 147,333 ----------- Consumer Goods & Related (1.44%) *Irena Huta Szkla Gospodarcz (PDR)........ 1,400 19,625 *Mostostal Exports (PDR).................. 13,775 77,353 Zwyeic Brewing Company (PDR)............. 1,019 77,443 ----------- 174,421 ----------- Financial Services (1.61%) Bank Rozwoju Eksportu S.A. (PDR)......... 9,200 135,565 Elektrim Trading Co. (PDR)............... 15,760 60,220 ----------- 195,785 ----------- TOTAL POLAND....................... 517,539 ----------- RUSSIA (.46%) Telecommunications (.46%) *Petersburg Long Distance Inc. ........... 11,000 56,375 ----------- SINGAPORE (1.43%) Capital Goods (1.43%) Clipsal Industries Holdings Ltd. ........ 48,000 103,680 GP Batteries Int'l. Ltd. ................ 29,000 69,600 ----------- TOTAL SINGAPORE.................... 173,280 ----------- 4 BLANCHARD WORLDWIDE EMERGING MARKETS FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) (Left column) Shares Value ------ ----- SLOVENIA (.51%) Banking (.51%) *Slovenia Kredit Bank (IDR)............... 210 $ 61,377 ----------- SOUTH AFRICA (5.34%) Basic Industries (1.54%) *Iscor Ltd. .............................. 72,633 90,120 Sasol Ltd. .............................. 10,000 96,718 ----------- 186,838 ----------- Consumer Goods & Related (1.08%) *JD Group................................. 17,000 62,245 South African Breweries Ltd. ............ 2,500 69,085 ----------- 131,330 ----------- Financial Services (.60%) Barlow Rand Ltd. ........................ 3,700 37,320 *Nedcor Ltd. ............................. 2,900 35,461 ----------- 72,781 ----------- Real Estate (1.23%) Safmarine & Rennie Hldgs. Ltd. .......... 48,000 149,223 ----------- Metals & Mining (.89%) Samancor Ltd. ........................... 7,800 108,311 ----------- TOTAL SOUTH AFRICA................. 648,483 ----------- TAIWAN (6.02%) Basic Industries (.82%) *Tuntex Distinct (GDS).................... 8,500 99,875 ----------- Industrial & Related (1.16%) Principal Pacific Construction Conv. Bond --------- 2.13%, 10/1/98......................... $150,000 140,997 ----------- Shares Investment Companies (4.04%) ------ *Taiwan Opportunities Fund Ltd. .......... 47,500 490,200 ----------- TOTAL TAIWAN....................... 731,072 ----------- (Right column) Shares Value ------ ----- THAILAND (9.11%) Capital Goods (.37%) *Hana Microelectronics.................... 12,000 $ 45,131 ----------- Financial Services (7.68%) Bangkok Bank Public Co. Ltd. ............ 20,000 193,535 Dhana Siam Finance & Securities Co. ..... 33,000 140,882 General Finance & Securities............. 46,500 185,282 MDX Corporation Ltd. .................... 31,500 65,318 Nat'l Finance & Securities............... 40,000 136,613 Siam City Bank Ltd. ..................... 140,000 143,728 Siam City Credit Fin. & Securities....... 22,000 67,087 ----------- 932,445 ----------- Transportation (1.06%) Precious Shipping Corp. ................. 12,000 128,807 ----------- TOTAL THAILAND..................... 1,106,383 ----------- URUGUAY (.69%) Financial Services (.69%) *Banco Commercial S.A. ................... 6,400 83,200 ----------- TOTAL EMERGING MARKETS SECURITIES (IDENTIFIED COST $12,596,388)..................... 11,205,168 ----------- Principal SHORT-TERM SECURITIES (2.89%) --------- U.S. GOVERNMENT OBLIGATIONS (2.89%) U.S. Treasury Bill 5.50%, 5/4/95 (AMORTIZED COST $349,840).......... $350,000 349,840 ----------- TOTAL INVESTMENTS (IDENTIFIED COST $12,946,228)(a) (95.20%). 11,555,008 CASH AND OTHER ASSETS IN EXCESS OF LIABILITIES (4.80%)(b).......... 583,044 ----------- NET ASSETS (100%).................. $12,138,052 =========== (a) The aggregate cost for federal income tax purposes is $13,038,908; the gross unrealized appreciation is $460,586 and the gross unrealized depreciation is $1,944,486; resulting in net unrealized depreciation of $1,483,900. (b) Includes one open forward currency contract as of April 30, 1995. The Fund sold 15,761 South African Commercial Rand and purchased US $4,360 for delivery on May 2, 1995. At April 30, 1995, there was no unrealized appreciation or depreciation on this contract. * Non-income producing. (d) Registered under SEC rule 144A; resale restricted as to qualified institutional buyers, represents 1.31% of net assets. See notes to financial statements. 5 BLANCHARD WORLDWIDE EMERGING MARKETS FUND-PORTFOLIO OF INVESTMENTS April 30, 1995 (continued) Schedule of Foreign Currency Held as of April 30, 1995 Currency Held Cost Market Value ------------- ---- ------------ Argentina Peso........................ 102,859 $102,864 $102,854 So. African Commercial Rand........... 188,067 52,323 51,970 -------- -------- $155,187 $154,824 ======== ======== 6 BLANCHARD WORLDWIDE EMERGING MARKETS FUND Statement of Assets and Liabilities April 30, 1995 Assets: Investments in securities, at value (Identified Cost $12,946,228) (note 1).................. $11,555,008 Cash....................................................... 479,261 Foreign currencies (Identified Cost $155,187).............. 154,824 Receivables for: Investments sold........................................ 452,347 Shares of beneficial interest sold...................... 158,840 Dividends............................................... 25,083 Interest................................................ 3,652 Foreign withholding tax reclaimable..................... 308 Deferred organizational costs (note 1...................... 116,081 ----------- Total assets...................................... 12,945,404 ----------- Liabilities: Payables for: Investments purchased................................... 762,573 Accrued expenses and other liabilities..................... 44,779 ----------- Total liabilities................................. 807,352 ----------- Net assets........................................ $12,138,052 =========== Net assets are comprised of: Paid in capital (unlimited authorized shares of beneficial interest, $.01 par value, 1,895,181 shares outstanding). $16,198,715 Accumulated investment loss-net ........................... (115,247) Accumulated realized loss-net.............................. (2,552,372) Unrealized net depreciation of investments................. (1,393,044) ----------- Net assets................................................. $12,138,052 =========== Net asset value per share.................................. $6.40 ===== See notes to financial statements. 7 BLANCHARD WORLDWIDE EMERGING MARKETS FUND STATEMENT OF OPERATIONS For the Year Ended April 30, 1995
Investment income: Interest (net of $3,051 foreign withholding tax)........................ $ 187,123 Dividends (net of $7,632 foreign withholding tax)....................... 122,193 ----------- Total income........................................................ 309,316 ----------- Expenses Investment management fee (note 2)...................................... $ 174,720 Custodian fees.......................................................... 90,580 Accounting fees......................................................... 73,203 Plan of distribution fees (note 3)...................................... 72,335 Transfer agent fees..................................................... 54,178 Professional fees....................................................... 47,739 Organizational expenses................................................. 29,000 Registration fees....................................................... 27,099 Shareholder reports and notices......................................... 19,067 Trustees' fees, retirement plan curtailment and other expenses (note 5). 16,786 Other................................................................... 1,606 --------- Total expenses...................................................... 606,313 Less: Expenses absorbed by Manager (note 2)......................... (90,297) --------- Net expenses............................................................ 516,016 ----------- Investment loss - net................................................... (206,700) ----------- Realized and unrealized gain (loss) - net (note 1): Investments in securities-net (net of $20,951 foreign capital gains tax) (2,292,242) Foreign currency contracts and foreign exchange transactions-net...................................................... (167,440) (2,459,682) --------- Change in unrealized appreciation on investments-net and translation of other assets and liabilities donominated in foreign currencies-net................................. (1,382,453) ----------- Net realized and unrealized losses...................................... (3,842,135) ----------- Net decrease in net assets resulting from operations.................... $(4,048,835) -----------
See notes to financial statements. 8 BLANCHARD WORLDWIDE EMERGING MARKETS FUND STATEMENT OF CHANGES IN NET ASSETS
For the period March 1, 1994* For the (commencement of Year Ended operations) to April 30, 1995 April 30, 1994 -------------- -------------- Increase (decrease) in net assets: Operations: Investment loss-net.................................................. $ (206,700) $ (707) Realized loss-net.................................................... (2,459,682) (530) Change in unrealized appreciation or depreciation-net................ (1,382,453) (10,591) ----------- ---------- Net decrease in net assets resulting from operations................. (4,048,835) (11,828) ----------- ---------- Transactions in shares of beneficial interest-net increase (note 6).... 8,144,318 7,554,397 ----------- ---------- Net increase in net assets....................................... 4,095,483 7,542,569 Net assets: Beginning of year.................................................... 8,042,569 500,000 ----------- ---------- End of year (including accumulated investment loss-net of $115,247 and $707, respectively)............................................ $12,138,052 $8,042,569 =========== ========== *Commencement of operations.
See notes to financial statements. 9 BLANCHARD WORLDWIDE EMERGING MARKETS FUND NOTES TO FINANCIAL STATEMENTS April 30, 1995 NOTE 1-Organization and Accounting Policies: Blanchard Worldwide Emerging Markets Fund (the "Fund"), formerly known as the Blanchard Emerging Markets Growth & Income Fund, is a series of Blanchard Funds which was organized as a Massachusetts business trust on January 24, 1986. The Fund is a registered, open-end non-diversified management investment company under the Investment Company Act of 1940 (the "Act"). The Fund had no operations before March 1, 1994 other than the sale of 62,500 shares of beneficial interest for $500,000 to Sheffield Management Company (the "Manager"). The following is a summary of the significant accounting policies followed by the Fund: A. Valuation of Investments-Portfolio securities traded on domestic or foreign exchanges are valued at the 4 PM EST price on that date, or if no sale is made on that day, at the closing bid price (or the mean price in cases where a mean is reported instead of the closing bid). In cases where a security is traded on more than one exchange, it is valued at the quotation on the exchange determined to be the primary market for such security by the Trustees or the Manager. All other portfolio securities for which over-the-counter market quotations are readily available are valued at the latest available bid prices. Short-term debt securities which mature in 60 days or less are valued at amortized cost if their original maturity was 60 days or less. Short-term debt securities having a maturity date of more than sixty days at the time of purchase are valued on a mark to market basis until sixty days prior to maturity and thereafter at amortized cost based on their value on the 61st day. All other securities and other assets of the Fund are valued at fair value as determined in good faith by the Trustees. Foreign currency exchange rates are determined when such rates are made available to the Fund at times prior to the close of the New York Stock Exchange. The abilities of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a particular country, industry or region. B. Accounting for Investments and Investment Income Transactions-Security transactions are accounted for on the trade date (date the order to buy or sell is executed). Realized gains and losses on security transactions are determined on the identified cost method. Dividend income and other distributions are recorded on the ex-dividend date, except that certain dividends from foreign securities are recorded as soon as the Fund is informed after the ex-dividend date. Interest income is accrued daily. Premiums or discounts on debt securities are amortized or accreted as adjustments to interest income over the lives of such securities. C. Foreign Currency Contracts & Translation-The books and records of the Fund are maintained in U.S. dollars as follows: (1) the foreign currency market value of investment securities, forward currency contracts, and other assets and liabilities denominated in foreign currencies are translated at the exchange rates at the end of the period; and (2) purchases, sales, income and expenses are translated at the rates of exchange prevailing on the respective dates of such transactions. The Fund does not separately identify that portion of the results of operations of the Fund that arise as a result of changes in the exchange rates from the fluctuations that arise from changes in market prices of equity investments during the year. Foreign security and currency transactions may involve certain considerations and risks not typically associated with those of domestic origin as a result of, among other factors, the level of governmental supervision and regulation of foreign securities markets and the possibility of political or economic instability. 10 BLANCHARD WORLDWIDE EMERGING MARKETS FUND NOTES TO FINANCIAL STATEMENTS-(continued) April 30, 1995 The Fund may enter into forward currency contracts to protect the U.S. dollar value of securities and related receivables and payables against changes in future foreign exchange rates. Forward currency contracts are valued based upon the current forward rates. Fluctuations in the value of such contracts are recorded as unrealized gains or losses; realized gains or losses include net gains or losses on contracts which have settled. The Fund generally enters into a forward currency contract as a hedge against foreign exchange rate fluctuation upon the purchase or sale of a security denominated in a foreign currency. The Fund maintains, as collateral, U.S. Government debt obligations in an amount equal to or greater than its net obligation for forward foreign currency contracts. Risks may arise as a result of the potential inability of the counterparts to meet the terms of their contracts. D. Federal Income Tax Status-It is the Fund's policy to comply with the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable income to its shareholders. Accordingly, no federal income tax provision is required. E. Dividends and Distributions to Shareholders-The Fund records dividends and distributions to its shareholders on the record date. The amount of dividends and distributions from net investment income and net realized capital gains are determined in accordance with federal income tax regulations which may differ from generally accepted accounting principles. These "book/tax" differences are either considered temporary or permanent in nature. To the extent these differences are permanent in nature, such amounts are reclassified within the capital accounts based on their federal tax-basis treatment; temporary differences do not require reclassification. Dividends and distributions which exceed net investment income or net realized capital gains for financial reporting purposes but not for tax purposes are reported as dividends in excess of net investment income or distributions in excess of net realized capital gains. To the extent they exceed net investment income or net realized capital gains for tax purposes, they are reported as distributions of paid-in capital. F. Organizational Expenses-The Fund's Manager paid the organizational expenses of the Fund incurred prior to the public offering of its shares amounting to $145,001. The Fund is liable to the Manager for these expenses and has deferred and is amortizing such expenses on the straight-line method over five years from the date of commencement of the Fund's operations. G. Other-Certain expenses of the Blanchard Funds are allocated among the Funds based upon their relative average net assets. NOTE 2-Investment Management Agreement: Pursuant to a management agreement (the "Agreement"), the Manager manages the Fund and the investment of the Fund's assets, subject at all times to the supervision of the Fund's Trustees. In addition to providing overall business management and administrative services, the Manager selects, monitors and evaluates the Portfolio Managers described below. The Manager receives from the Fund an advisory fee payable monthly at an annual rate of 1.25% of the Fund's average daily net assets. Expenses of the Fund, exclusive of taxes, interest, brokerage commissions, distribution fees, extraordinary expenses and certain other excludable expenses for which a waiver has been obtained, are subject to the 11 BLANCHARD WORLDWIDE EMERGING MARKETS FUND NOTES TO FINANCIAL STATEMENTS-(continued) April 30, 1995 expense limitation imposed by one state in which shares of the Fund are offered for sale. For the year ended April 30, 1995, the Fund's expenses did not exceed the above limitation. Certain officers and/or Trustees of the Fund are officers and/or directors of the Manager. The Manager has sub-advisory agreements with Martin Currie, Inc. (Equities Sector) and OFFITBANK (Fixed Income Sector) to serve, as the Portfolio Managers for their respective sectors of the Fund. The Manager has advised the Fund that the amount of fees paid to the Portfolio Managers was $59,427 and $2,703, respectively. The Manager voluntarily waived a portion of its advisory fee, which amounted to $90,297, for the year ended April 30, 1995. NOTE 3-Distribution Agreement and Plan: Pursuant to a Distribution Agreement, Sheffield Investments, Inc. (the "Distributor"), an affiliated company of the Manager, acts as principal distributor of the Fund's shares. The Distributor has the exclusive right to distribute Fund shares directly or through other broker-dealers. The Fund has adopted a Distribution Plan (the "Plan") pursuant to Rule 12b-1 under the Act which provides that the Fund may finance activities which are primarily intended to result in the sale of the Fund's shares, including but not limited to advertising, printing of prospectuses and reports for other than existing shareholders, preparation and distribution of advertising material and sales literature, and payments to dealers and shareholder servicing agents who enter into agreements with the Manager or Distributor. Pursuant to the plan, the Fund may pay distribution fees not to exceed .50% per annum of the Fund's average daily net assets. Provided that the Plan continues in effect, any cumulative expenses incurred by the Distributor on or after March 1, 1994, but not yet reimbursed by the Fund, may be reimbursed through future distribution fees from the Fund. The Distributor has advised the Fund that at April 30, 1995, the unreimbursed distribution expenses amounted to $1,010,046. If the Plan is terminated or discontinued in accordance with its terms, the obligation of the Fund to make payments to the Distributor pursuant to the Plan will cease and the Fund will not be required to make any payments past the date the Plan is terminated. NOTE 4-Acquisition Agreement: Sheffield Management Company (the "Manager") and Sheffield Investments, Inc. (the "Distributor"), have entered into an acquisition agreement (the "Acquisition Agreement") with Signet Banking Corporation and two of its subsidiaries ("Signet"), dated February 15, 1995, pursuant to which Sheffield will sell to Signet the assets relating to, and the ability to succeed to contracts with, the Blanchard Funds, including Blanchard Worldwide Emerging Market Fund (collectively, the "Funds"). The transactions contemplated by the Acquisition Agreement which have been approved by the Board of Trustees of the Funds are conditioned upon the approval of the shareholders of each Fund, of (1) a new investment management agreement with Signet, (2) a new distribution agreement with Federated Securities Corp., and (3) certain other conditions. No material changes are contemplated in the operation of the Funds and no management or distribution and administration fee increases are being proposed. 12 BLANCHARD WORLDWIDE EMERGING MARKETS FUND NOTES TO FINANCIAL STATEMENTS-(continued) April 30, 1995 NOTE 5-Security Transactions and Transactions with Affiliates: Purchases and sales of portfolio securities for the year ended April 30, 1995, excluding short-term investments, aggregated $29,004,768 and $16,231,172, respectively. The Distributor has advised the Fund that it received $17,513 from shareholders as account opening fees for the year ended April 30, 1995. The Manager has advised the Fund that, for the same period, it incurred costs, which were reimbursed by the Fund, amounting to $16,196 for performing internal accounting and transfer agency functions for the Fund. The Funds have adopted an unfunded noncontributory pension plan (the "Plan") covering all independent directors/trustees of the Funds who will have served as an independent director/trustee for at least five years at the time of retirement. Benefits under this plan are based on an annual amount equal to 75% of the director/trustee fee at the time of retirement, plus 5% for each year of service in excess of five years of service but not in excess of ten years of service. Net periodic pension expense included in Trustees' fees, retirement plan curtailment and other expenses in the Statement of Operations for the year ended April 30, 1995 was $2,615. As indicated in Note 4, the Manager has entered into an agreement which provides for the acquisition of the Manager by Signet. Following the acquisition, the independent directors/trustees of the Funds will not stand for re-election. As a result, the Plan was curtailed and additional pension expense of $9,250 was recorded to reflect the previously unrecognized prior service costs of the independent directors/trustees. Included in accrued expenses and other liabilities at April 30, 1995 is $11,865 of accrued pension expense. NOTE 6-Shares of Beneficial Interest: For the period March 1, 1994 For the (commencement of Year Ended operations) April 30, 1995 to April 30, 1994 ---------------------- ------------------- Shares Amount Shares Amount ------ ------ ------ ------ Sold................. 2,641,403 $21,445,228 1,072,843 $8,573,224 Repurchased.......... (1,754,090) (13,300,910) (127,475) (1,018,827) --------- ----------- --------- ---------- Net increase......... 887,313 $ 8,144,318 945,368 $7,554,397 ========= =========== ========= ========== NOTE 7-Federal Income Taxes: Any capital or foreign currency loss incurred after October 31 through the end of the Fund's taxable year is deemed to arise on the first day of the Fund's next taxable year, if so elected. The Fund elected to defer a net capital loss of $2,474,894 and a currency loss of $144,048 incurred during such period in fiscal 1995. As of April 30, 1995, the Fund had temporary book/tax differences primarily attributable to wash sales and post-October capital and currency loss deferrals. To reflect reclassifications arising from permanent book/tax differences for the year ended April 30, 1995, accumulated realized loss-net was credited $92,160 and accumulated net loss was debited $92,160. 13 BLANCHARD WORLDWIDE EMERGING MARKETS FUND NOTES TO FINANCIAL STATEMENTS-(continued) April 30, 1995 NOTE 8-Financial Highlights: Selected ratios and per share data for a share of beneficial interest outstanding:
For the period March 1, 1994 For the (commencement Year Ended of operations) April 30, 1995 to April 30, 1994 -------------- ----------------- Per Share Operating Performance: Net asset value, beginning of year..................................... $7.98 $8.00 ----- ----- Income from investment operations: Net investment income (loss)........................................ (.11) (.00)(3) Net gains or loss on securities (both realized and unrealized)...... (1.47) (.02) ----- ----- Net (loss) from investment operations............................ (1.58) (.02) ----- ----- Less dividends and distributions: Dividends from investment income.................................... - - Distributions from realized gains................................... - - ----- ----- Change in net asset value........................................ (1.58) (.02) ----- ----- Net asset value, end of period......................................... $6.40 $7.98 ===== ===== Total return (not annualized).......................................... (19.80%) (.25%) Ratios/Supplemental Data: Net assets, end of period ($ Million)............................... $12 $8 Ratio of expenses to average net assets............................. 3.59%(2) 3.07%(1)(2) Ratio of net investment income (loss) to average net assets......... (1.44%)(2) (.10%)(1)(2) Portfolio turnover.................................................. 132% 0% - ----------------- (1) Annualized. (2) The ratios of expenses to average net assets and net investment (loss) to average net assets would have been 4.22% and (2.07%), respectively, for the year ended April 30, 1995 and 4.42% and (1.45%), respectively, for the period ended April 30, 1994, if a portion of the Fund's expenses had not been voluntarily deferred and absorbed by the Manager (See note 2). (3) Less than one cent per share.
14 BLANCHARD WORLDWIDE EMERGING MARKETS FUND REPORT OF INDEPENDENT ACCOUNTANTS To the Trustees and Shareholders of Blanchard Worldwide Emerging Markets Fund In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Blanchard Worldwide Emerging Markets Fund (the "Fund") at April 30, 1995, the results of its operations for the year then ended, and the changes in its net assets and the financial highlights for the year then ended and for the period March 1, 1994 (commencement of operations) through April30, 1994, in conformity with generally accepted accounting principles. These financial statements and financial highlights (hereafter referred to as "financial statements") are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at April 30, 1995 by correspondence with the custodian and brokers and the application of alternative auditing procedures where confirmations from brokers were not received, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York 10036 June 20, 1995 15 (Left Column) Portfolio Advisers Martin Currie Inc. Equity Securities OFFITBANK Fixed Income Securities Custodian and Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Legal Counsel Kramer, Levin, Naftalis, Nessen, Kamin & Frankel Blanchard Worldwide Emerging Markets Fund 41 Madison Ave., 24th Floor New York, NY 10010-2267 (Right Column) ------------------ Blanchard Worldwide Emerging Markets Fund ------------------ Annual Report April 30, 1995 Managed by: Sheffield Management Company 41 Madison Ave., 24th Floor New York, NY 10010-2267 1-800-922-7771 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD GROWTH & INCOME FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Growth & Income Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History 2 Investment Objectives, Policies and Restrictions 2 Portfolio Transactions 17 Computation of Net Asset Value 20 Performance Information 21 Additional Purchase and Redemption Information 24 Tax Matters 25 The Management of the FUND 34 Management Services 37 Administrative Services 40 Distribution Plan Description of the FUND 42 Shareholder Reports 43 Appendix A A-1 Financial Statements B-1 Manager Virtus Capital Management, Inc. Portfolio Adviser The Chase Manhattan Bank, N.A. Distributor Federated Securities Corp. Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in the Blanchard Growth & Income Fund's (the "FUND") Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. INVESTMENT OBJECTIVES, POLICIES AND RESTRICTIONS The Fund seeks its investment objectives by investing 100% of its net assets in the Growth & Income Portfolio (the "Portfolio") . The Portfolio has investment objectives identical to the Fund and invests in accordance with investment policies and restrictions identical to those of the Fund. The investment objectives of the Fund and the Portfolio may not be changed except by a majority vote of shareholders. The investment policies of the Fund and the Portfolio, as described below, are not fundamental and may be changed without shareholder approval. The investment restrictions of the Fund and the Portfolio, as described below, are fundamental and may not be changed without approval by a majority of the outstanding shares of the Fund or the Portfolio which means the vote of the lesser of (i) 67% or more of the shares of the Fund or total beneficial interests of the Portfolio present at the meeting, if the holders of more than 50% of the outstanding shares of the Fund or total beneficial interests of the Portfolio are present or represented by proxy or (ii) more than 50% of the outstanding shares of the Fund or total beneficial interests of the Portfolio. Investment Policies The following information supplements and should be read in conjunction with the Prospectus discussion of investment policies and with the Appendix included at the end of the Prospectus. U.S. Government Securities - Although the Portfolio invests primarily in common stocks, it may also maintain cash reserves and invest in a variety of short-term debt securities, including obligations issued or guaranteed by the U.S. Government or its agencies or instrumentalities, which have remaining maturities not exceeding one year. Agencies and instrumentalities that issue or guarantee debt securities and have been established or sponsored by the U.S. Government include the Bank for Cooperatives, the Export-Import Bank, the Federal Farm Credit System, the Federal Home Loan Banks, the Federal Home Loan Mortgage Corporation, the Federal Intermediate Credit Banks, the Federal Land Banks, the Federal National Mortgage Association and the Student Loan Marketing Association. Certain of these securities may not be backed by the full faith and credit of the U.S. Government. Bank Obligations - Investments by the Portfolio in short-term debt securities as described above also include investments in obligations (including certificates of deposit and bankers' acceptances) of those U.S. banks which have total assets at the time of purchase in excess of $1 billion and the deposits of which are insured by either the Bank Insurance Fund or the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation. A certificate of deposit is an interest-bearing negotiable certificate issued by a bank against funds deposited in the bank. A bankers' acceptance is a short-term draft drawn on a commercial bank by a borrower, usually in connection with an international commercial transaction. Although the borrower is liable for payment of the draft, the bank unconditionally guarantees to pay the draft at its face value on the maturity date. -2- Commercial Paper - Investments by the Portfolio in short-term debt securities also included investments in commercial paper, which represents short-term, unsecured promissory notes issued in bearer form by bank holding companies, corporations and finance companies. The commercial paper purchased for the Portfolio will consist of direct obligations of domestic issuers which, at the time of investment, are (i) rated "P-1" by Moody's or "A-1" or better by Standard & Poor's, (ii) issued or guaranteed as to principal and interest by issuers or guarantors having an existing debt security rating of "Aa" or better by Moody's or "AA" or better by Standard & Poor's, or (iii) securities which, if not rated, are, in the Portfolio Adviser's opinion, of an investment quality comparable to rated commercial paper in which the Portfolio may invest. The rating "P-1" is the highest commercial paper rating assigned by Moody's and the ratings "A-1" and "A-1+" are the highest commercial paper ratings assigned by Standard & Poor's. Debt securities rated "Aa" or better by Moody's or "AA" or better by Standard & Poor's are generally regarded as high-grade obligations and such ratings indicate that the ability to pay principal and interest is very strong. Repurchase Agreements - The Portfolio may, when appropriate, enter into repurchase agreements only with member banks of the Federal Reserve System and securities dealers believed creditworthy, and only if fully collateralized by U.S. Government obligations or other securities in which the Portfolio is permitted to invest. Under the terms of a typical repurchase agreement, the Portfolio would acquire an underlying debt instrument for a relatively short period (usually not more than one week) subject to an obligation of the seller to repurchase the instrument and the Portfolio to resell the instrument at a fixed price and time, thereby determining the yield during the Portfolio's holding period. This procedure results in a fixed rate of return insulated from market fluctuations during such period. A repurchase agreement is subject to the risk that the seller may fail to repurchase the security. Repurchase agreements may be deemed under the 1940 Act to be loans collateralized by the underlying securities. All repurchase agreements entered into by the Portfolio will be fully collateralized at all times during the period of the agreement in that the value of the underlying security will be at least equal to the amount of the loan, including the accrued interest thereon, and the Portfolio or its custodian or sub-custodian will have possession of the collateral, which the Board of Trustees believes will give it a valid, perfected security interest in the collateral. Whether a repurchase agreement is the purchase and sale of a security or a collateralized loan has not been conclusively established. This might become an issue in the event of the bankruptcy of the other party to the transaction. In the event of default by the seller under a repurchase agreement construed to be a collateralized loan, the underlying securities would not be owned by the Portfolio, but would only constitute collateral for the seller's obligation to pay the repurchase price. Therefore, the Portfolio may suffer time delays and incur costs in connection with the disposition of the collateral. The Board of Trustees believes that the collateral underlying repurchase agreements may be more susceptible to claims of the seller's creditors than would be the case with securities owned by the Portfolio. The Portfolio will not be invested in a repurchase agreement maturing in more than seven days if any such investment together with securities subject to restrictions on transfer held by the Portfolio exceed 10% of its total net assets. Repurchase agreements are also subject to the same risks described below with respect to stand-by commitments. Loans of Portfolio Securities - Certain securities dealers who make "short sales" or who wish to obtain particular securities for short periods may seek to borrow them from an institutional investor such as the Portfolio. The Portfolio reserves the right to seek to increase its income by lending its portfolio securities. Under present regulatory policies, including those of the Board of Governors of the Federal Reserve System and the Securities and Exchange Commission, such loans may be made only to member firms of the New York Stock Exchange, and are required to be secured continuously by collateral in cash, cash equivalents, or U.S. Government securities maintained on a current basis in an amount at least equal to the market value of the securities loaned. Under a loan, the Portfolio has the right to call a loan and obtain the securities loaned at any time on five days' notice. During the existence of a loan, the Portfolio continues to receive the equivalent of the interest or dividends paid by the issuer on the securities loaned and also receives compensation based on investment of the collateral. The Portfolio does not, however, have the right to vote any securities having voting rights during the existence of the loan, but can call the loan in anticipation of an important vote to be taken among holders of the securities or of the giving or withholding of their consent on a material matter affecting the investment. -3- As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral if the borrower of the securities experiences financial difficulty. However, the loans will be made only to dealers deemed by the Portfolio to be of good standing, and when, in the judgment of the Portfolio, the consideration that can be earned currently from securities loans of this type justifies the attendant risk. In the event the Portfolio makes securities loans, it is not intended that the value of the securities loaned would exceed 30% of the value of the Portfolio's total assets. Additional Policies Regarding Futures and Options Transactions Futures Contracts in General - A futures contract is an agreement between two parties for the future delivery of fixed income securities or for the payment or acceptance of a cash settlement in the case of futures contracts on an index of fixed income securities or stock index futures contracts. A "sale" of a futures contract means the contractual obligation to deliver the securities at a specified price on a specified date, or to make the cash settlement called for by the contract. Futures contracts have been designed by exchanges which have been designated "contract markets" by the Commodity Futures Trading Commission ("CFTC") and must be executed through a brokerage firm, known as a futures commission merchant, which is a member of the relevant contract market. Futures contracts trade on these markets, and the exchanges, through their clearing organizations, guarantee that the contracts will be performed as between the clearing members of the exchange. Presently, futures contracts are based on such debt securities as long-term U.S. Treasury Bonds, Treasury Notes, Government National Mortgage Association modified pass-through mortgage-backed securities, three-month U.S. Treasury Bills, bank certificates of deposit, and on indexes of municipal, corporate and government bonds. While futures contracts based on securities do provide for the delivery and acceptance of securities, such deliveries and acceptances are very seldom made. Generally, a futures contract is terminated by entering into an offsetting transaction. The Portfolio will incur brokerage fees when it purchases and sells futures contracts. At the time such a purchase or sale is made, the Portfolio must provide cash or money market securities as a deposit known as "margin". The initial deposit required will vary, but may be as low as 2% or less of a contract's face value. Daily thereafter, the futures contract is valued through a process known as "marking to market", and the Portfolio may receive or be required to pay "variation margin" as the futures contract becomes more or less valuable. At the time of delivery of securities pursuant to a futures contract based on securities, adjustments are made to recognize differences in value arising from the delivery of securities with a different interest rate than the specific security that provides the standard for the contract. In some (but not many) cases, securities called for by a futures contract may not have been issued when the contract was written. Futures contracts on indexes of securities are settled through the making and acceptance of cash settlements based on changes in value of the underlying rate or index between the time the contract is entered into and the time it is liquidated. Futures Contracts on Fixed Income Securities and Related Indexes - The Portfolio may enter into transactions in futures contracts on fixed income securities and indexes of municipal, corporate and government securities for the purpose of hedging a relevant portion of its portfolio. Such transactions will be entered into where movements in the value of the securities or index underlying a futures contract can be expected to correlate closely with movements in the value of securities held in the Portfolio's portfolio. The Portfolio may sell futures contracts in anticipation of a general rise in the level of interest rates, which would result in a decline in the value of fixed income securities held in the Portfolio's portfolio. If the expected rise in interest rates occurs, the Portfolio may realize gains on its futures position which should offset all or part of the decline in value of fixed income portfolio securities. The Portfolio could protect against such decline by selling fixed income securities, but such a strategy would involve higher transaction costs than the sale of futures contracts and, if interest rates again declined, the Portfolio would be unable to take advantage of the resulting market advance without purchases of additional securities. -4- The purpose of the purchase or sale of a futures contract on fixed income securities and indexes of municipal, corporate and government securities, in the case of the Portfolio, which hold or intend to acquire long-term debt securities, is to protect the Portfolio from fluctuations in interest rates without actually buying or selling long-term debt securities. For example, if long-term bonds are held in the Portfolio's portfolio, and interest rates were expected to increase, the Portfolio might enter into futures contracts for the sale of debt securities. Such a sale would have much the same effect as selling an equivalent value of the long-term bonds held by the Portfolio. If interest rates did increase, the value of the debt securities in the Portfolio would decline, but the value of the futures contracts to the Portfolio would increase at approximately the same rate thereby keeping the net asset value of the Portfolio from declining as much as it otherwise would have. When the Portfolio is not fully invested and a decline in interest rates is anticipated, which would increase the cost of fixed income securities which the Portfolio intends to acquire, it may purchase futures contracts. In the event that the projected decline in interest rates occurs, the increased cost of the securities acquired by the Portfolio should be offset, in whole or part, by gains on the futures contracts by entering into offsetting transactions on the contract market on which the initial purchase was effected. In a substantial majority of these transactions, the Portfolio will purchase fixed income securities upon termination of the long futures positions, but under unusual market conditions, a long futures position may be terminated without a corresponding purchase of securities. The Portfolio will sell futures contracts on indexes of municipal, corporate and government securities for the purpose of hedging against a broad market decline which would cause a general reduction in the value of a portfolio of municipal securities, or in the value of a portion of such portfolio. To the extent that municipal securities held in a portfolio are the same, or have the same characteristics, as the securities comprising the index underlying the futures contract, changes in the value of the index should correlate closely with changes in the value of the Portfolio's portfolio securities. Under such circumstances, the Portfolio may be able to offset declines in the value of its portfolio securities through gains on its futures position. Similarly, the Portfolio may purchase futures contracts on indexes of municipal securities where it expects to acquire a portfolio of municipal securities and anticipates an increase in the cost of such securities prior to acquisition. To the extent that the securities to be acquired reflect the composition of the index underlying the futures contract, such increased cost may be offset, in whole or in part, through gains on the futures position. To the extent that the Portfolio enters into futures contracts for other than municipal bonds, there is a possibility that the value of such futures contracts would not vary in direct proportion to the value of the Portfolio's portfolio securities since the value of municipal bonds and other debt securities may not react exactly the same to a general change in interest rates and may react differently to factors other than changes in the general level of interest rates. The Portfolio's overall performance would be adversely affected if the value of its futures contracts for securities other than municipal bonds declined disproportionately to the value of the Portfolio's municipal bond portfolio. Conversely, the Portfolio's overall performance would be positively affected if the value of such futures contracts increased disproportionately to the value of its municipal bond portfolio. Similarly, when it is expected that interest rates may decline, futures contracts on fixed income securities and indexes of municipal, corporate and government securities may be purchased for the purpose of hedging against anticipated purchases of long-term bonds at higher prices. Since the fluctuations in the value of such futures contracts should be similar to that of long-term bonds, the Portfolio could take advantage of the anticipated rise in the value of long-term bonds without actually buying them until the market had stabilized. At that time, the futures contracts could be liquidated and the Portfolio's cash reserves could then be used to buy long-term bonds in the cash market. Similar results could be accomplished by selling bonds with long maturities and investing in bonds with short maturities when interest rates are expected to increase. However, since the futures market is more liquid than the cash market, the use of these futures contracts as an investment technique allows the Portfolio to act in anticipation of such an interest rate decline without having to sell its portfolio securities. To the extent the Portfolio enters into futures contracts for this purpose, the assets in the segregated asset accounts maintained by the Portfolio will consist of cash, cash equivalents or high quality debt securities from the Portfolio's portfolio in an amount equal to the difference between the fluctuating market value of such futures contract and the aggregate value of the initial deposit and variation margin payments made by the Portfolio with respect to such futures contracts. -5- Stock Index Futures Contracts - The Portfolio may sell stock index futures contracts in order to offset a decrease in market value of its securities portfolio that might otherwise result from a market decline. The Portfolio may do so either to hedge the value of its portfolio as a whole, or to protect against declines, occurring prior to sales of securities, in the value of portfolio securities to be sold. Conversely, the Portfolio may purchase stock index futures contracts in order to protect against anticipated increases in the cost of securities to be acquired. As also described above with respect to futures contracts on fixed income securities and related indexes, in a substantial majority of these transactions, the Portfolio would purchase such securities upon termination of the long futures position, but under unusual market conditions, a long futures position may be terminated without a corresponding purchase of securities. In addition, the Portfolio may utilize stock index futures contracts in anticipation of changes in the composition of its portfolio. For example, in the event that the Portfolio expects to narrow the range of industry groups represented in its portfolio, the Portfolio may, prior to making purchases of the actual securities, establish a long futures position based on a more restricted index, such as an index comprised of securities of a particular industry group. As such securities are acquired, the Portfolio's futures positions would be closed out. The Portfolio may also sell futures contracts in connection with this strategy, in order to protect against the possibility that the value of the securities to be sold as part of the restructuring of the Portfolio's portfolio will decline prior to the time of sale. Options on Futures Contracts on Fixed Income Securities and Related Indexes - The Portfolio may purchase put options on futures contracts in which the Portfolio is permitted to invest for the purpose of hedging a relevant portion of its portfolio against an anticipated decline in the values of portfolio securities resulting from increases in interest rates, and may purchase call options on such futures contracts as a hedge against an interest rate decline when it is not fully invested. The Portfolio would write options on these futures contracts primarily for the purpose of terminating existing positions. Options on Stock Index Futures Contracts, Options on Stock Indexes and Options on Equity Securities - The Portfolio may purchase put options on stock index futures contracts, stock indexes or equity securities for the purpose of hedging the relevant portion of its securities portfolio against an anticipated market-wide decline or against declines in the values of individual portfolio securities, and the Portfolio may purchase call options on such futures contracts as a hedge against a market advance when it is not fully invested. The Portfolio would write options on such futures contracts primarily for the purpose of terminating existing positions. In general, options on stock indexes will be employed in lieu of options on stock index futures contracts only where they present an opportunity to hedge at lower cost. With respect to options on equity securities, the Portfolio may, under certain circumstances, purchase a combination of call options on such securities and U.S. Treasury bills. The Portfolio Adviser believes that such a combination may more closely parallel movements in the value of the security underlying the call option than would the option itself. Further, while the Portfolio generally would not write options on individual portfolio securities it may do so under limited circumstances known as "targeted sales" and "targeted buys", which involve the writing of call or put options in an attempt to purchase or sell portfolio securities at specific desired prices. The Portfolio would receive a fee, or a "premium", for the writing of the option. For example, where the Portfolio seeks to sell portfolio securities at a "targeted" price, it may write a call option at that price. In the event that the market rises above the exercise price, the Portfolio would receive its "targeted" price, upon the exercise of the option, as well as the premium income. Also, where the Portfolio seeks to buy portfolio securities at a "targeted" price, it may write a put option at that price for which it will receive the premium income. In the event that the market declines below the exercise price, the Portfolio would pay its "targeted" price upon the exercise of the option. In the event that the market does not move in the direction or to the extent anticipated, however, the targeted sale or buy might not be successful and the Portfolio could sustain a loss on the transaction which may not be offset by the premium received. In addition, the Portfolio may be required to forego the benefits of an intervening increase or decline in value of the underlying security. -6- Risk Factors Associated with Futures and Options Transactions In addition to any risk factors which may be described above, the following sets forth certain information regarding the potential risks associated with the Portfolio's futures and options transactions. Risk of Imperfect Correlation - The Portfolio's ability effectively to hedge all or a portion of its portfolio through transactions in futures, options on futures or options on stock indexes depends on the degree to which movements in the value of the securities or index underlying such hedging instrument correlate with movements in the value of the relevant portion of the Portfolio's portfolio. If the values of the portfolio securities being hedged do not move in the same amount or direction as the underlying security or index, the hedging strategy for the Portfolio might not be successful and the Portfolio could sustain losses on its hedging transactions which would not be offset by gains on its portfolio. It is also possible that there may be a negative correlation between the security or index underlying a futures or option contract and the portfolio securities being hedged, which could result in losses both on the hedging transaction and the portfolio securities. In such instances, the Portfolio's overall return could be less than if the hedging transactions had not been undertaken. Stock index futures or options based on a narrower index of securities may present greater risk than options or futures based on a broad market index, as a narrower index is more susceptible to rapid and extreme fluctuations resulting from changes in the value of a small number of securities. The Portfolio would, however, effect transactions in such futures or options only for hedging purposes. The trading of futures and options on indexes involves the additional risk of imperfect correlation between movements in the futures or option price and the value of the underlying index. The anticipated spread between the prices may be distorted due to differences in the nature of the markets, such as differences in margin requirements, the liquidity of such markets and the participation of speculators in the futures and options market. The purchase of an option on a futures contract also involves the risk that changes in the value of underlying futures contract will not be fully reflected in the value of the option purchased. The risk of imperfect correlation, however, generally tends to diminish as the maturity date of the futures contract or termination date of the option approaches. The risk incurred in purchasing an option on a futures contract is limited to the amount of the premium plus related transaction costs, although it may be necessary under certain circumstances to exercise the option and enter into the underlying futures contract in order to realize a profit. Under certain extreme market conditions, it is possible that the Portfolio will not be able to establish hedging positions, or that any hedging strategy adopted will be insufficient to completely protect the Portfolio. The Portfolio will purchase or sell futures contracts or options only if, in the Portfolio's Adviser's judgment, there is expected to be a sufficient degree of correlation between movements in the value of such instruments and changes in the value of the relevant portion of the Portfolio's portfolio for the hedge to be effective. There can be no assurance that the Portfolio Adviser's judgment will be accurate. Potential Lack of a Liquid Secondary Market - The ordinary spreads between prices in the cash and futures markets, due to differences in the natures of those markets, are subject to distortions. First, all participants in the futures market are subject to initial deposit and variation margin requirements. This could require the Portfolio to post additional cash or cash equivalents as the value of the position fluctuates. Further, rather than meeting additional variation margin requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the cash and futures markets. Second, the liquidity of the futures or options market may be lacking. Prior to exercise or expiration, a futures or option position may be terminated only by entering into a closing purchase or sale transaction, which requires a secondary market on the exchange on which the position was originally established. While the Portfolio will establish a futures or option position only if there appears to be a liquid secondary market therefor, there can be no assurance that such a market will exist for any particular futures or option contract at any specific time. In such event, it may not be possible to close out a position held by the Portfolio, which could require the Portfolio to purchase or sell the instrument underlying the position, make or receive a cash settlement, or meet ongoing variation margin requirements. The inability to close out futures or option positions also could have an adverse impact on the Portfolio's ability effectively to hedge its portfolio, or the relevant portion thereof. -7- The liquidity of a secondary market in a futures contract or an option on a futures contract may be adversely affected by "daily price fluctuation limits" established by the exchanges, which limit the amount of fluctuation in the price of a contract during a single trading day and prohibit trading beyond such limits once they have been reached. The trading of futures and options contracts also is subject to the risk of trading halts, suspensions, exchange or clearing house equipment failures, government intervention, insolvency of the brokerage firm or clearing house or other disruptions of normal trading activity, which could at times make it difficult or impossible to liquidate existing positions or to recover excess variation margin payments. Risk of Predicting Interest Rate Movements - Investments in futures contracts on fixed income securities and related indexes involve the risk that if the Portfolio's Adviser's investment judgment concerning the general direction of interest rates is incorrect, the Portfolio's overall performance may be poorer than if it had not entered into any such contract. For example, if the Portfolio has been hedged against the possibility of an increase in interest rates which would adversely affect the price of bonds held in its portfolio and interest rates decrease instead, the Portfolio will lose part or all of the benefit of the increased value of its bonds which have been hedged because it will have offsetting losses in its futures positions. In addition, in such situations, if the Portfolio has insufficient cash, it may have to sell bonds from its portfolio to meet daily variation margin requirements, possibly at a time when it may be disadvantageous to do so. Such sale of bonds may be, but will not necessarily be, at increased prices which reflect the rising market. Trading and Position Limits - Each contract market on which futures and option contracts are traded has established a number of limitations governing the maximum number of positions which may be held by a trader, whether acting alone or in concert with others. The Portfolio Adviser does not believe that these trading and position limits will have an adverse impact on the hedging strategies regarding the Portfolio's portfolios. Restrictions on the Use of Futures and Option Contracts Regulations of the CFTC require that the Portfolio enters into transactions in futures contracts and options thereon for hedging purposes only, in order to assure that it is not deemed to be a "commodity pool" under such regulations. In particular, CFTC regulations require that all short futures positions be entered into for the purpose of hedging the value of securities held in the Portfolio's portfolio, and that all long futures positions either constitute bona fide hedging transactions, as defined in such regulations, or have a total value not in excess of an amount determined by reference to certain cash and securities positions maintained for the Portfolio, and accrued profits on such positions. In addition, the Portfolio may not purchase or sell such instruments if, immediately thereafter, the sum of the amount of initial margin deposits on its existing futures positions and premiums paid for options on futures contracts would exceed 5% of the market value of the Portfolio's total assets. When the Portfolio purchases a futures contract, an amount of cash or cash equivalents or high quality debt securities will be deposited in a segregated account with the Portfolio's custodian so that the amount so segregated, plus the initial deposit and variation margin held in the account of its broker, will at all times equal the value of the futures contract, thereby insuring that the use of such futures is unleveraged. The Portfolio's ability to engage in the hedging transactions described herein may be limited by the current federal income tax requirement that the Portfolio derive less than 30% of its gross income from the sale or other disposition of stock or securities held for less than three months. In addition to the foregoing requirements, the Portfolio's Board of Trustees has adopted an additional restriction on the use of futures contracts and options thereon, requiring that the aggregate market value of the futures contracts held by the Portfolio not exceed 50% of the market value of its total assets. Neither this restriction nor any policy with respect to the above-referenced restrictions, would be changed by the Board of Trustees without considering the policies and concerns of the various federal and state regulatory agencies. -8- Investment Restrictions In addition to the investment restrictions set forth below, the Fund has adopted the following investment restrictions to enable it to invest in the Portfolio: It is a fundamental policy of the Fund that because it holds no portfolio securities except interests in the Portfolio, the Fund's investment objective, policies and restrictions shall be identical to the Portfolio's investment objective, policies and restrictions, except for the following: the Fund (1) may invest more than 5% of its assets in another issuer, (2) may, consistent with Section 12 of the 1940 Act, invest in securities issued by other registered investment companies, (3) may invest more than 10% of its net assets in the securities of a registered investment company, (4) may hold more than 10% of the voting securities of a registered investment company, (5) will concentrate its investments in the investment company and (6) will not issue senior securities except as permitted by an exemptive order of the SEC. The Portfolio may not: (1) borrow money or pledge, mortgage or hypothecate its assets, except that, as a temporary measure for extraordinary or emergency purposes, it may borrow in an amount not to exceed 1/3 of the current value of its net assets, including the amount borrowed, and may pledge, mortgage or hypothecate not more than 1/3 of such assets to secure such borrowings (it is intended that, aside from reverse repurchase transactions, money would be borrowed by the Portfolio only from banks and only to accommodate requests for the repurchase of shares of the Portfolio while effecting an orderly liquidation of portfolio securities), provided that collateral arrangements with respect to the Portfolio's permissible futures and options transactions, including initial and variation margin, are not considered to be a pledge of assets for purposes of this restriction; the Portfolio will not purchase investment securities if its outstanding borrowing, including reverse repurchase agreements, exceeds 5% of the value of the Portfolio's total assets; (2) purchase any security or evidence of interest therein on margin, except that such short-term credit may be obtained as may be necessary for the clearance of purchases and sales of securities and except that, with respect to the Portfolio's permissible options and futures transactions, deposits of initial and variation margin may be made in connection with the purchase, ownership, holding or sale of futures or options positions; (3) underwrite securities issued by other persons except insofar as the Portfolio may technically be deemed an underwriter under the Securities Act of 1933 in selling a portfolio security; (4) write, purchase or sell any put or call option or any combination thereof, provided that this shall not prevent (i) the purchase, ownership, holding or sale of warrants where the grantor of the warrants is the issuer of the underlying securities, (ii) the writing, purchasing or selling of puts, calls or combinations thereof with respect to U.S. Government securities or (iii) permissible futures and options transactions, the writing, purchasing, ownership, holding or selling of futures and options positions or of puts, calls or combinations thereof with respect to futures; (5) knowingly invest in securities which are subject to legal or contractual restrictions on resale (including securities that are not readily marketable, but not including repurchase agreements maturing in not more than -9- seven days) if, as a result thereof, more than 10% of the Fund's or Portfolio's total assets (taken at market value) would be so invested (including repurchase agreements maturing in more than seven days); (6) purchase or sell real estate (including limited partnership interests but excluding securities secured by real estate or interests therein), interests in oil, gas or mineral leases, commodities or commodity contracts in the ordinary course of business, other than (i) permissible futures and options transactions or (ii) forward purchases and sales of foreign currencies or securities; (7) purchase securities of any issuer if such purchase at the time thereof would cause more than 10% of the voting securities of such issuer to be held by the Portfolio; (8) make short sales of securities or maintain a short position; except that the Portfolio may make such short sales of securities or maintain a short position if when a short position is open the Portfolio owns an equal amount of such securities or securities convertible into or exchangeable, without payment of any further consideration, for securities of the same issue as, and equal in amount to, the securities sold short, and unless not more than 10% of the Portfolio's net assets (taken at market value) is held as collateral for such sales at any one time (it is the present intention of management to make such sales only for the purpose of deferring realization of gain or loss for federal income tax purposes; such sales would not be made of securities subject to outstanding options); (9) concentrate its investments in any particular industry, but if it is deemed appropriate for the achievement of the Portfolio's investment objective, up to 25% of the assets of the Portfolio, at market value at the time of each investment, may be invested in any one industry, except that positions in options and futures shall not be subject to this restriction; or (10) issue any senior security (as that term is defined in the 1940 Act) if such issuance is specifically prohibited by the 1940 Act or the rules and regulations promulgated thereunder, provided that collateral arrangements with respect to the Portfolio's permissible options and futures transactions, including deposits of initial and variation margin, are not considered to be the issuance of a senior security for purposes of this restriction. The Portfolio is not permitted to make loans to other persons, except (i) through the lending of its portfolio securities and provided that any such loans not exceed 30% of the Portfolio's total assets (taken at market value), (ii) through the use of repurchase agreements or the purchase of short-term obligations and provided that not more than 10% of the Portfolio's total assets will be invested in repurchase agreements maturing in more than seven days, or (iii) by purchasing, subject to the limitation in paragraph 5 above, a portion of an issue of debt securities of types commonly distributed privately to financial institutions, for which purposes the purchase of short-term commercial paper or a portion of an issue of debt securities which are part of an issue to the public shall not be considered the making of a loan. For purposes of the investment restrictions described above and the state and federal restrictions described below, the issuer of a tax-exempt security is deemed to be the entity (public or private) ultimately responsible for the payment of the principal of and interest on the security. For purposes of Investment Restriction No. 9, industrial development bonds, where the payment of principal and interest is the ultimate responsibility of companies within the same industry, are grouped together as an "industry". -10- The Portfolio has also adopted the following non-fundamental investment policy which may be changed without shareholder approval. The Portfolio may enter into repurchase agreements (a purchase of and a simultaneous commitment to resell a security at an agreed-upon price on an agreed-upon date) only with member banks of the Federal Reserve System and securities dealers believed creditworthy and only if fully collateralized by U.S. Government obligations or other securities in which the Portfolio is permitted to invest. If the vendor of a repurchase agreement fails to pay the sum agreed to on the agreed-upon delivery date, the Portfolio would have the right to sell the securities constituting the collateral; however, the Portfolio might thereby incur a loss and in certain cases may not be permitted to sell such securities. Moreover, as noted above in paragraph 5, the Portfolio may not, as a matter of fundamental policy, invest more than 10% of its total assets in repurchase agreements maturing in more than seven days. The Portfolio has no current intention of engaging in the following activities in the foreseeable future: (i) writing, purchasing or selling puts, calls or combinations thereof with respect to U.S. Government securities; (ii) purchasing voting securities of any issuer. State and Federal Restrictions: In order to comply with certain federal and state statutes and regulatory policies, as a matter of operating policy, the Portfolio will not: (i) sell any security which it does not own unless by virtue of its ownership of other securities the Portfolio has at the time of sale a right to obtain securities, without payment of further consideration, equivalent in kind and amount to the securities sold and provided that if such right is conditional the sale is made upon the same conditions, (ii) invest for the purpose of exercising control or management, (iii) invest more than 5% of the Fund's assets in companies which, including predecessors, have a record of less than three years' continuous operation, (iv) invest in warrants valued at the lower of cost or market, in excess of 5% of the value of the Fund's net assets, and no more than 2% of such value may be warrants which are not listed on the New York or American Stock Exchanges, (v) purchase or retain in the Portfolio's portfolio any securities issued by an issuer any of whose officers, directors, trustees or security holders is an officer or trustee of the Portfolio, or is an officer or director of the Portfolio Adviser, if after the purchase of the securities of such issuer by the Portfolio one or more of such persons owns beneficially more than 1/2 of 1% of the shares or securities, or both, all taken at market value, of such issuer, and such persons owning more than 1/2 of 1% of such shares or securities together own beneficially more than 5% of such shares or securities, or both, all taken at market value, or (vi) as to 50% of the Portfolio's total assets, purchase securities of any issuer if such purchase at the time thereof would cause the Portfolio to hold more than 10% of any class of securities of such issuer, for which purposes all indebtedness of an issuer shall be deemed a single class and all preferred stock of an issuer shall be deemed a single class. These policies are not fundamental and may be changed by the Portfolio's Board of Trustees without shareholder approval. Percentage and Rating Restrictions: If a percentage or rating restriction on investment or utilization of assets set forth above or referred to in the Prospectus is adhered to at the time an investment is made or assets are so utilized, a later change in percentage resulting from changes in the value of the portfolio securities or a later change in the rating of a portfolio security of the Portfolio will not be considered a violation of policy. PORTFOLIO TRANSACTIONS Specific decisions to purchase or sell securities for the Portfolio are made by a portfolio manager who is an employee of the Portfolio Adviser and who is appointed and supervised by senior officers of the Portfolio Adviser. Changes in the Portfolio's investments are reviewed by the Board of Trustees. The Portfolio's portfolio manager may serve other clients of the Portfolio Adviser in a similar capacity. The frequency of the Portfolio's portfolio transactions, the portfolio turnover rate, will vary from year to year depending upon market conditions. Because a high turnover rate may increase transaction costs and the possibility of taxable short-term gains, the Portfolio Adviser will weigh the added costs of short-term investment against anticipated gains. -11- The primary consideration in placing portfolio security transactions with broker-dealers for execution is to obtain and maintain the availability of execution at the most favorable prices and in the most effective manner possible. The Portfolio Adviser attempts to achieve this result by selecting broker-dealers to execute portfolio transactions on behalf of the Portfolio and other clients of the Portfolio Adviser on the basis of their professional capability, the value and quality of their brokerage services, and the level of their brokerage commissions. Debt securities are traded principally in the over-the-counter market through dealers acting on their own account and not as brokers. In the case of securities traded in the over-the-counter market (where no stated commissions are paid but the prices include a dealer's markup or markdown), the Portfolio Adviser normally seeks to deal directly with the primary market makers unless, in its opinion, best execution is available elsewhere. In the case of securities purchased from underwriters, the cost of such securities generally includes a fixed underwriting commission or concession. From time to time, soliciting dealer fees are available to the Portfolio Adviser on the tender of the Portfolio's portfolio securities in so-called tender or exchange offers. Such soliciting dealer fees are in effect recaptured for the Portfolios by the Portfolio Adviser. At present, no other recapture arrangements are in effect. Under Section 28(e) of the Securities Exchange Act of 1934, the Portfolio Adviser may cause the Portfolio to pay a broker-dealer which provides brokerage and research services to the Adviser an amount of commission for effecting a securities transaction for the Portfolio in excess of the amount other broker-dealers would have charged for the transaction if the Portfolio Adviser determines in good faith that the greater commission is reasonable in relation to the value of the brokerage and research services provided by the executing broker-dealer viewed in terms of either a particular transaction or the Portfolio Adviser's overall responsibilities to the Portfolio or to its clients. Not all of such services are useful or of value in advising the Portfolio. The term "brokerage and research services" includes advice as to the value of securities, the advisability of investing in, purchasing or selling securities, and the availability of securities or of purchasers or sellers of securities, furnishing analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts, and effecting securities transactions and performing functions incidental thereto such as clearance and settlement. Although commissions paid on every transaction will, in the judgment of the Portfolio Adviser, be reasonable in relation to the value of the brokerage services provided, commissions exceeding those which another broker might charge may be paid to broker-dealers who were selected to execute transactions on behalf of the Portfolio and the Portfolio Adviser's other clients as part of providing advice as to the availability of securities or of purchasers or sellers of securities and services in effecting securities transactions and performing functions incidental thereto, such as clearance and settlement. Broker-dealers may be willing to furnish statistical, research and other factual information or services ("Research") to the Portfolio Adviser for no consideration other than brokerage or underwriting commissions. Securities may be bought or sold through such broker-dealers, but at present, unless otherwise directed by the Portfolio, a commission higher than one charged elsewhere will not be paid to such a firm solely because it provided Research to the Portfolio Adviser. The Portfolio Adviser's investment management personnel will attempt to evaluate the quality of Research provided by brokers. Results of this effort are sometimes used by the Portfolio Adviser as a consideration in the selection of brokers to execute portfolio transactions. However, the Portfolio Adviser would be unable to quantify the amount of commissions which are paid as a result of such Research because a substantial number of transactions are effected through brokers which provide Research but which are selected principally because of their execution capabilities. The management fees that the Funds pay to the Portfolio Adviser will not be reduced as a consequence of the Adviser's receipt of brokerage and research services. To the extent the Portfolio's portfolio transactions are used to obtain such services, the brokerage commissions paid by the Portfolio will exceed those that might otherwise be paid, by an amount which cannot be presently determined. Such services would be -12- useful and of value to the Portfolio Adviser in serving the Portfolio and other clients and, conversely, such services obtained by the placement of brokerage business of other clients would be useful to the Portfolio Adviser in carrying out its obligations to the Portfolio. While such services are not expected to reduce the expenses of the Portfolio Adviser, the Portfolio Adviser would, through use of the services, avoid the additional expenses which would be incurred if it should attempt to develop comparable information through its own staff. In certain instances, there may be securities that are suitable for the Portfolio as well as one or more of the Portfolio Adviser's other clients. Investment decisions for the Portfolio and for the Portfolio Adviser's other clients are made with a view to achieving their respective investment objectives. It may develop that the same investment decision is made for more than one client or that a particular security is bought or sold for only one client even though it might be held by, or bought or sold for, other clients. Likewise, a particular security may be bought for one or more clients when one or more clients are selling that same security. Some simultaneous transactions are inevitable when several clients receive investment advice from the same investment adviser, particularly when the same security is suitable for the investment objectives of more than one client. When the Portfolio or the Portfolio Adviser's other clients are simultaneously engaged in the purchase or sale of the same security, the securities are allocated among clients in a manner believed to be equitable to each. It is recognized that in some cases this system could have a detrimental effect on the price or volume of the security as far as the Portfolio is concerned. However, it is believed that the ability of the Portfolio to participate in volume transactions will generally produce better executions for the Portfolio. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The Portfolio will invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees of the Portfolio. Portfolio securities which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, currently 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the Portfolio. Money market instruments with less than sixty days remaining to maturity when acquired by the Portfolio will be valued on an amortized cost basis by the Portfolio, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the Portfolio acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior -13- to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Trustees of the Portfolio determine during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders to purchase or redeem Shares of the Fund received by dealers prior to 4:15 P.M. (New York Time) will be confirmed at the previous offering or redemption price computed as of the close of trading on the options exchanges (normally 4:15 P.M., New York Time), provided the order is received by the FUND's Transfer Agent prior to 4:15 P.M. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 P.M. will be confirmed at the next computed offering or redemption price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the period ended February 28, 1995 was 21.89%. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return -14- with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect until December, 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a RIC, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. Because the FUND invests all of its assets in the Portfolio, which is classified as a partnership for federal income tax purposes, the FUND will be deemed to own a proportionate share of the assets and income of the Portfolio for -15- purposes of determining whether the FUND satisfies the requirements (described more fully below) necessary to qualify as a regulated investment company. In addition to satisfying the Distribution Requirement, a RIC must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the company's principal business of investing in stock or securities) and other income (including gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it held for less than three months. However, foreign currency gains that are directly related to the company's investment in stock or securities are not treated as short-short gains. Similarly, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since losses are disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months is not treated as gross income derived from the sale or other disposition of a security within the meaning of the Short-Short Gain Test. However, income attributable to realized market appreciation will be so treated for this purpose. In general, gain or loss recognized by the Portfolio on the disposition of an asset (and allocated to the Fund) will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased at a market discount will be treated as ordinary income to the extent of the portion of the discount that accrued while the Portfolio held the obligation. In addition, under the rules of Code Section 988, a portion of gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto, and (with certain exceptions) gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, will generally be treated as ordinary income or loss. In general, for purposes of determining whether capital gain or loss recognized by the FUND (through its Portfolio) on the disposition of an asset is long-term or short-term, the holding period of the asset may be affected if (1) the asset is used to close a "short sale" (which may include the acquisition of a put option) or is substantially identical to another asset so used, (2) the asset is otherwise held by the Portfolio as part of a "straddle" (as defined) or (3) the asset is stock and the Portfolio grants an in-the-money qualified covered call option with respect thereto. In addition, the FUND may be required to defer the recognition of a loss on a disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain allocated to the FUND on the lapse of, or any gain or loss allocated to it from a closing transaction with respect to, an option written by the Portfolio will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of such an option will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the Portfolio may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts are subject to special tax treatment as "Section 1256 contracts." Such contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated as of such date. Gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any gain or loss recognized upon the actual termination of such contracts during the year. The combined capital gain or loss for the year with respect to Section 1256 contracts is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. (The Portfolio may elect not to -16- have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments that are not Section 1256 contracts.) The IRS has held in private rulings that constructive gains arising from deemed year-end dispositions of Section 1256 contracts will not be taken into account for purposes of the Short-Short Gain Test. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it were incurred in the succeeding year. In addition to the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of a RIC's taxable year, at least 50% of the value of its assets must consist of cash and cash items, U.S. Government securities, securities of other RICs, and securities of other issuers (as to which the RIC has not invested more than 5% of the value of its total assets in securities of such issuer and as to which it does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other RICs), or in two or more issuers which the RIC controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security and not the issuer of the option. If for any taxable year the FUND does not qualify as a RIC, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a RIC that fails to distribute in each calendar year an amount equal to 98% of its ordinary taxable income for the calendar year and 98% of its capital gain net income for the one-year period ended on October 31 of the year. The balance of such income must be distributed during the next calendar year. The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. The FUND may in certain circumstances have to liquidate portfolio investments in order to effect such distributions. FUND Distributions The FUND intends to distribute substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but will qualify for the 70% dividends-received deduction for corporate shareholders only to the extent discussed below. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute such gains annually. Net capital gain distributed and designated as a capital gain dividend is taxable to shareholders as long-term capital gain, regardless of the shareholder's holding period in his shares and the time when such gain was recognized by the Portfolio. -17- If the FUND elects to retain its net capital gain, it will be taxed thereon (except to the extent of any available capital loss carryovers) at the 35% corporate tax rate. In this case, the FUND would expect to elect to have shareholders of record on the last day of the taxable year treated as if each received a distribution of his pro rata share of the gain, with the result that each would be required to report his pro rata share of such gain on his tax return as a long-term capital gain, would receive a refundable tax credit for his pro rata share of the tax paid by the FUND on the gain, and would increase the tax basis for his shares by an amount equal to the deemed distribution less the credit. Ordinary income dividends distributed by the FUND will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as S corporations, which are not eligible for the deduction) to the extent of the portion of the distribution attributed to "qualifying dividends" received by the Portfolio during the taxable year from domestic corporations. A dividend received by the Portfolio will not be treated as a qualifying dividend (1) if it was received with respect to stock that the Portfolio held for less than 46 days (91 days in the case of certain preferred stock), subject to the limitations of Code Sections 246(c)(3) and (4) and 246A. Moreover, the dividends-received deduction for a corporate shareholder will also be disallowed if the corporate shareholder fails to satisfy the foregoing requirements with respect to its FUND shares or the FUND fails to satisfy them with respect to its interest in the Portfolio. Investment income that may be received by the Portfolio from foreign sources may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with a number of foreign countries, which entitle the Portfolio to reduced rates of, or exemptions from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the future mix of the Portfolio's investment in various countries is not known. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholders' tax basis in their shares; any excess will be treated as gain from a sale of the shares, as discussed more fully below. Distributions by the FUND will be treated in the manner described above whether they are paid in cash or reinvested in additional shares of the FUND (or of another fund). In addition, if a shareholder's cost for his shares already reflects undistributed (realized or unrealized) income or gain, a subsequent distribution of such amounts will be taxable to the shareholder in the manner described above, although economically it constitutes a return of capital. Ordinarily, shareholders are required to take distributions into account in the year in which they are made. However, dividends declared by the Fund in October, November or December of any calendar year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of dividends and the proceeds of redemption paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all to the Fund, (2) who is subject to backup withholding pursuant to a notice from the IRS for failure to report interest or dividend income properly, or (3) who has not otherwise certified to the FUND that it is not subject to backup withholding. Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of his shares in an amount equal to the difference between the amount realized on the shares and his adjusted tax basis in them. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the disposition. In general, gain or loss arising from a sale or redemption of -18- FUND shares will constitute capital gain or loss, and will be long-term capital gain or loss if the shares were held longer than one year. However, a capital loss arising from a disposition of shares held for six months or less will be treated as a long-term capital loss to the extent of any amount of capital gain dividends received on the shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (alluded to above in connection with the dividends-received deduction for corporations) will generally apply. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of noncorporate taxpayers, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income received from the FUND is "effectively connected" with a U.S. trade or business carried on by the shareholder. If the income is not effectively connected in the above sense, ordinary income dividends distributed to a foreign shareholder will be subject to U.S. withholding tax at the rate of 30% (or a lower treaty rate, if one applies) of the gross amount of the dividend. Such a shareholder would generally be exempt from U.S. federal income tax on gains realized on a sale of FUND shares and capital gain dividends. If income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and gain realized upon the sale of FUND shares will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless they furnish the FUND with proper notification of their exempt status. The tax consequences to foreign shareholders entitled to claim the benefits of applicable treaties may differ from one treaty to another. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of any foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly alter the conclusions expressed herein, perhaps with retroactive effect. Rules of state and local taxation of dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of their investing in the FUND in light of their particular circumstances. -19- THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP. John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the
-20- Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center--Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee, of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated
-21- Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology.
-22- Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.S. Government Securities Fund: 1-3 years; Federated U.S. Government Securities Fund: 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc,; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust: International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust; Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II; Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Treasury Obligation; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of June 30, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. -23- To the best knowledge of the FUND, as of June 30, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. The Trustees and officers of the Portfolio and their principal occupations for at least the past five years are set forth below. Their titles may have varied during that period. Asterisks indicate those Trustees who are "interested persons" (as defined in the 1940 Act) of the Portfolio. Unless otherwise indicated below, the address of each officer is 6 St. James Avenue, Suite 900, Boston, Massachusetts 02116. Stuart W. Cragin, Jr. Trustee, Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, International Equity 108 Valley Road Portfolio, Mutual Fund Group, Mutual Fund Trust and Mutual Fund Greenwich, CT 06870 Variable Annuity Trust; President, Fairfield Testing Laboratory, Inc. (laboratory providing materials testing), since 1989; prior to 1989 he served in a variety of positions with Union Camp Corporation, Trinity Paper & Plastics Corp., and Conover Industries, Inc. Irv Thode Trustee, Growth and Income Portfolio, Capital Growth Portfolio, Trustee Global Fixed Income Portfolio, International Equity Portfolio, 80 Perkins Road Mutual Fund Group, Mutual Fund Trust and Mutual Fund Variable Greenwich, CT 06830 Annuity Trust; Retired; Vice President, Eastern Region Sales, Quotron Systems; 1983 through 1990 has held numerous executive positions with Control Data Corporation including President of Latin American operations and General Manager of its Data Services business. H. Richard Vartabedian* Trustee and Chairman, Growth and Income Portfolio, Capital Chairman Growth Portfolio, Global Fixed Income Portfolio, International P.O. Box 296 Equity Portfolio; Trustee, Mutual Fund Group, Mutual Fund Trust Beach Road and Mutual Fund Variable Annuity Trust; Retired; Former Senior Hendrick's Head Investment Officer, Division Executive of the Investment Southport, Maine 04576 Management Division of The Chase Manhattan Bank, N.A., 1980 through 1991. Fergus Reid, III* Trustee, Growth and Income Portfolio, Capital Growth Portfolio, Trustee Global Fixed Income Portfolio, International Equity Portfolio; 971 West Road Trustee and Chairman, Mutual Fund Group, Mutual Fund Trust and New Canaan, CT 06840 Mutual Fund Variable Annuity Trust; Chairman and Chief Executive Officer, Lumelite Corporation, since September, 1985. Joseph Harkins* Retired; Trustee, Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, International Equity 257 Plantation Circle South Portfolio, Mutual Fund Group, Mutual Fund Trust and Mutual Fund Ponte Vedra Beach, FL 32082 Variable Annuity Trust; Commercial Sector Executive and Executive Vice President of The Chase Manhattan Bank, N.A. from 1985 through 1989; Director of Blessing Corporation and Jefferson Insurance Company of New York, Monticello Insurance Company. Richard E. Ten Haken Trustee of Growth and Income Portfolio, Capital Growth Portfolio, Trustee Global Fixed Income Portfolio, International Equity Portfolio, 4 Barnfield Road Mutual Fund Group, Mutual Fund Trust and Mutual Fund Variable Pittsford, New York 14534 Annuity Trust; District Superintendent of Schools, Monroe No. 2 and Orleans Counties, New York; Chairman of the Finance and
-24- Audit and Accounting Committees, Member of the Executive Committee and Vice President, New York State Teachers' Retirement System. William J. Armstrong Trustee of Growth and Income Portfolio, Capital Growth Portfolio, Trustee Global Fixed Income Portfolio, International Equity Portfolio, 49 Aspen Way Mutual Fund Group, Mutual Fund Trust and Mutual Fund Upper Saddle River, NJ 07458 Variable Annuity Trust; Vice President and Treasurer, Ingersoll- Rand Company (Woodcliff Lake, New Jersey). John R.H. Blum Trustee of Growth and Income Portfolio, Capital Growth Portfolio, Trustee Global Fixed Income Portfolio, International Equity Portfolio, 1 John Street Mutual Fund Group, Mutual Fund Trust and Mutual Fund Variable Millerton, New York 12546 Annuity Trust; Partner in the law firm of Richards, O'Neil & Allegaert.
Officers and Trustees Compensation
- -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts $-0- $1,816.00 for the Fund Complex Trustee
* Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds. -25- MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any 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 willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties imposed upon it by its contract with the Trust. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares whose needs are served by the Fund's objectives, and properly -26- servicing these accounts, the Fund may be able to curb sharp fluctuations in rates of redemptions and sales. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known asa "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certaincircumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further providesthat the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in theDeclaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. -27- APPENDIX A DESCRIPTION OF RATINGS Bond Ratings Moody's Investors Service, Inc. -- Bonds which are rated Aaa are judged to be 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 positions of such issues. Bonds which are rated Aa are judged to be of high quality by all standards. Together with 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 fluctuations 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. 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. Moody's applies numerical modifiers "1," "2" and "3" in each generic rating classification from Aa through B in its corporate bond rating system. The modifier "1" indicates that the security ranks in the higher end of its generic rating category; the modifier "2" indicates a mid-range ranking; and the modifier "3" indicates that the issue ranks in the lower end of its generic rating category. Standard & Poor's Corporation Bonds rated AAA have the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. Bonds rated AA have a very strong capacity to pay interest and repay principal and differ from AAA issues only in small degree. Bonds rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of change in circumstances and economic conditions than bonds in higher rated categories. Bonds rated AAA by Fitch are judged by Fitch to be strictly high grade, broadly marketable, suitable for investment by trustees and fiduciary institutions liable to but slight market fluctuation other than through changes in the money rate. The prime feature of an AAA bond is showing of earnings several times or many times interest requirements, with such stability of applicable earnings that safety is beyond reasonable question whatever changes occur in conditions. Bonds rated AA by Fitch are judged by Fitch to be of safety virtually beyond question and are readily salable, whose merits are not unlike those of the AAA class, but whose margin of safety is less strikingly broad. The issue may be the obligation of a small company, strongly secured but influenced as to rating by the lesser financial power of the enterprise and more local type market. Bonds rated Duff-1 are judged by Duff to be of the highest credit quality with negligible risk factors; only slightly more than U.S. Treasury debt. Bonds rated Duff-2, 3 and 4 are judged by Duff to be of high credit quality with strong protection factors. Risk is modest but may vary slightly from time to time because of economic conditions. Bonds rated TBW-1 are judged by Thomson BankWatch, Inc. to be of the highest credit quality with a very high degree of likelihood that principal and income will be paid on a timely basis. Bonds rated TBW-2 offer a strong degree of safety regarding repayment. The relative degree of safety, however, is not as high as TBW-1. Commercial Paper Ratings Moody's Commercial Paper ratings are opinions of the ability of issuers to repay punctually promissory obligations. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Prime 1-Highest Quality; Prime 2-Higher Quality; Prime 3-High Quality. A-1 vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues assigned the highest rating, A, are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2, and 3 to indicate the relative degree of safety. The designation A-1 indicates that the degree of safety regarding timely payment is either overwhelming or very strong. A "+" designation is applied to those issues rated "A-1" which possess safety characteristics. Capacity for timely payment on issues with the designation A-2 is strong. However, the relative degree of safety is not as high as for issues designated A-1. Issues carrying the designation A-3 have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. The rating Fitch-1 (Highest Grade) is the highest commercial rating assigned by Fitch. Paper rated Fitch-1 is regarded as having the strongest degree of assurance for timely payment. The rating Fitch-2 (Very Good Grade) is the second highest commercial paper rating assigned by Fitch which reflects an assurance of timely payment only slightly less in degree than the strongest issues. The rating Duff-1 is the highest commercial paper rating assigned by Duff. Paper rated Duff-1 is regarded as having very high certainty of timely payment with excellent liquidity factors which are supported by ample asset protection. Risk factors are minor. Paper rated Duff-2 is regarded as having good certainty of timely payment, good access to capital markets and sound liquidity factors and company fundamentals. Risk factors are small. A-2 STATEMENT OF ADDITIONAL INFORMATION BLANCHARD CAPITAL GROWTH FUND FEDERATED INVESTORS TOWER PITTSBURGH, PA 15222-3779 - -------------------------------------------------------------------------------- This Statement is not a prospectus but should be read in conjunction with the current prospectus dated August 7, 1995 (the "Prospectus"), pursuant to which the Blanchard Capital Growth Fund (the "FUND") is offered. Please retain this document for future reference. - -------------------------------------------------------------------------------- To obtain the Prospectus please call the FUND at 1-800-829-3863 - -------------------------------------------------------------------------------- TABLE OF CONTENTS Page General Information and History ............................................ 2 Investment Objective, Policies and Restrictions ............................ 2 Portfolio Transactions ..................................................... 15 Computation of Net Asset Value ............................................. 17 Performance Information .................................................... 19 Additional Purchase and Redemption Information ............................. 21 Tax Matters ................................................................ 22 The Management of the FUND ................................................. 31 Management Services ........................................................ 34 Administrative Services .................................................... 37 Distribution Plan .......................................................... 25 Description of the FUND .................................................... 39 Shareholder Reports ........................................................ 40 Appendix A ................................................................. A-1 Financial Statements ....................................................... B-1 Manager Virtus Capital Management, Inc. Portfolio Adviser The Chase Manhattan Bank, N.A. Distributor Federated Securities Corp. Transfer Agent United States Trust Company of New York Independent Accountants Price Waterhouse LLP Dated: August 7, 1995 GENERAL INFORMATION AND HISTORY As described in Blanchard Capital Growth's (the "FUND") Prospectus, the FUND is a non-diversified series of Blanchard Funds, a Massachusetts business trust that was organized under the name "Blanchard Strategic Growth Fund" (the "Trust"). The trustees of the Trust approved the change in the name of the Trust on December 4, 1990. INVESTMENT OBJECTIVE, POLICIES AND RESTRICTIONS The Fund seeks its investment objective by investing 100% of its assets in the Capital Growth Portfolio (the "Portfolio"). The Portfolio has an investment objective identical to the Fund and invests in accordance with investment policies and restrictions identical to those of the Fund. The investment objective of the Fund and the Portfolio may not be changed except by a majority vote of shareholders. The investment policies of the Fund and the Portfolio, as described below, are not fundamental and may be changed without shareholder approval. The investment restrictions of the Fund and the Portfolio, as described below, are fundamental and may not be changed without approval by a majority of the outstanding shares of the Fund or the Portfolio which means the vote of the lesser of (i) 67% or more of the shares of the Fund or total beneficial interests of the Portfolio present at the meeting, if the holders of more than 50% of the outstanding shares of the Fund or total beneficial interests of the Portfolio are present or represented by proxy or (ii) more than 50% of the outstanding shares of the Fund or total beneficial interests of the Portfolio. Investment Policies The following information supplements and should be read in conjunction with the Prospectus discussion of investment policies and with the Appendix included at the end of the Prospectus. U.S. Government Securities - Although the Portfolio invests primarily in common stocks, it may also maintain cash reserves and invest in a variety of short-term debt securities, including obligations issued or guaranteed by the U.S. Government or its agencies or instrumentalities, which have remaining maturities not exceeding one year. Agencies and instrumentalities that issue or guarantee debt securities and have been established or sponsored by the U.S. Government include the Bank for Cooperatives, the Export-Import Bank, the Federal Farm Credit System, the Federal Home Loan Banks, the Federal Home Loan Mortgage Corporation, the Federal Intermediate Credit Banks, the Federal Land Banks, the Federal National Mortgage Association and the Student Loan Marketing Association. Certain of these securities may not be backed by the full faith and credit of the U.S. Government. Bank Obligations - Investments by the Portfolio in short-term debt securities as described above also include investments in obligations (including certificates of deposit and bankers' acceptances) of those U.S. banks which have total assets at the time of purchase in excess of $1 billion and the deposits of which are insured by either the Bank Insurance Fund or the Savings Association Insurance Fund of the Federal Deposit Insurance Corporation. A certificate of deposit is an interest-bearing negotiable certificate issued by a bank against funds deposited in the bank. A bankers' acceptance is a short-term draft drawn on a commercial bank by a borrower, usually in connection with an international commercial transaction. Although the borrower is liable for payment of the draft, the bank unconditionally guarantees to pay the draft at its face value on the maturity date. -2- Commercial Paper - Investments by the Portfolio in short-term debt securities also include investments in commercial paper, which represents short-term, unsecured promissory notes issued in bearer form by bank holding companies, corporations and finance companies. The commercial paper purchased for the Portfolio will consist of direct obligations of domestic issuers which, at the time of investment, are (i) rated "P-1" by Moody's or "A-1" or better by Standard & Poor's, (ii) issued or guaranteed as to principal and interest by issuers or guarantors having an existing debt security rating of "Aa" or better by Moody's or "AA" or better by Standard & Poor's, or (iii) securities which, if not rated, are, in the Portfolio Adviser's opinion, of an investment quality comparable to rated commercial paper in which the Portfolio may invest. The rating "P-1" is the highest commercial paper rating assigned by Moody's and the ratings "A-1" and "A-1+" are the highest commercial paper ratings assigned by Standard & Poor's. Debt securities rated "Aa" or better by Moody's or "AA" or better by Standard & Poor's are generally regarded as high-grade obligations and such ratings indicate that the ability to pay principal and interest is very strong. Repurchase Agreements - The Portfolio may, when appropriate, enter into repurchase agreements only with member banks of the Federal Reserve System and securities dealers believed creditworthy, and only if fully collateralized by U.S. Government obligations or other securities in which the Portfolio is permitted to invest. Under the terms of a typical repurchase agreement, the Portfolio would acquire an underlying debt instrument for a relatively short period (usually not more than one week) subject to an obligation of the seller to repurchase the instrument and the Portfolio to resell the instrument at a fixed price and time, thereby determining the yield during the Portfolio's holding period. This procedure results in a fixed rate of return insulated from market fluctuations during such period. A repurchase agreement is subject to the risk that the seller may fail to repurchase the security. Repurchase agreements may be deemed under the 1940 Act to be loans collateralized by the underlying securities. All repurchase agreements entered into by the Portfolio will be fully collateralized at all times during the period of the agreement in that the value of the underlying security will be at least equal to the amount of the loan, including the accrued interest thereon, and the Portfolio or its custodian or sub-custodian will have possession of the collateral, which the Board of Trustees believes will give it a valid, perfected security interest in the collateral. Whether a repurchase agreement is the purchase and sale of a security or a collateralized loan has not been conclusively established. This might become an issue in the event of the bankruptcy of the other party to the transaction. In the event of default by the seller under a repurchase agreement construed to be a collateralized loan, the underlying securities would not be owned by the Portfolio, but would only constitute collateral for the seller's obligation to pay the repurchase price. Therefore, the Portfolio may suffer time delays and incur costs in connection with the disposition of the collateral. The Board of Trustees believes that the collateral underlying repurchase agreements may be more susceptible to claims of the seller's creditors than would be the case with securities owned by the Portfolio. The Portfolio will not be invested in a repurchase agreement maturing in more than seven days if any such investment together with securities subject to restrictions on transfer held by the Portfolio exceed 10% of its total net assets. Repurchase agreements are also subject to the same risks described below with respect to stand-by commitments. Loans of Portfolio Securities - Certain securities dealers who make "short sales" or who wish to obtain particular securities for short periods may seek to borrow them from an institutional investor such as the Portfolio. The Portfolio reserves the right to seek to increase its income by lending its portfolio securities. Under present regulatory policies, including those of the Board of Governors of the Federal Reserve System and the Securities and Exchange Commission, such loans may be made only to member firms of the New York Stock Exchange, and are required to be secured continuously by collateral in cash, cash equivalents, or U.S. Government securities maintained on a current basis in an amount at least equal to the market value of the securities loaned. Under a loan, the Portfolio has the right to call a loan and obtain the securities loaned at any time on five days' notice. During the existence of a loan, the Portfolio continues to receive the equivalent of the interest or dividends paid by the issuer on the securities loaned and also receives compensation based on investment of the collateral. The Portfolio does not, however, have the right to vote any securities having voting rights during the existence of the loan, but can call the loan in anticipation of an important vote to be taken among holders of the securities or of the giving or withholding of their consent on a material matter affecting the investment. -3- As with other extensions of credit, there are risks of delay in recovery or even loss of rights in the collateral if the borrower of the securities experiences financial difficulty. However, the loans will be made only to dealers deemed by the Portfolio to be of good standing, and when, in the judgment of the Portfolio, the consideration that can be earned currently from securities loans of this type justifies the attendant risk. In the event the Portfolio makes securities loans, it is not intended that the value of the securities loaned would exceed 30% of the value of the Portfolio's total assets. Additional Policies Regarding Futures and Options Transactions Futures Contracts in General - A futures contract is an agreement between two parties for the future delivery of fixed income securities or for the payment or acceptance of a cash settlement in the case of futures contracts on an index of fixed income securities or stock index futures contracts. A "sale" of a futures contract means the contractual obligation to deliver the securities at a specified price on a specified date, or to make the cash settlement called for by the contract. Futures contracts have been designed by exchanges which have been designated "contract markets" by the Commodity Futures Trading Commission ("CFTC") and must be executed through a brokerage firm, known as a futures commission merchant, which is a member of the relevant contract market. Futures contracts trade on these markets, and the exchanges, through their clearing organizations, guarantee that the contracts will be performed as between the clearing members of the exchange. Presently, futures contracts are based on such debt securities as long-term U.S. Treasury Bonds, Treasury Notes, Government National Mortgage Association modified pass-through mortgage-backed securities, three-month U.S. Treasury Bills, bank certificates of deposit, and on indexes of municipal, corporate and government bonds. While futures contracts based on securities do provide for the delivery and acceptance of securities, such deliveries and acceptances are very seldom made. Generally, a futures contract is terminated by entering into an offsetting transaction. The Portfolio will incur brokerage fees when it purchases and sells futures contracts. At the time such a purchase or sale is made, the Portfolio must provide cash or money market securities as a deposit known as "margin". The initial deposit required will vary, but may be as low as 2% or less of a contract's face value. Daily thereafter, the futures contract is valued through a process known as "marking to market", and the Portfolio may receive or be required to pay "variation margin" as the futures contract becomes more or less valuable. At the time of delivery of securities pursuant to a futures contract based on securities, adjustments are made to recognize differences in value arising from the delivery of securities with a different interest rate than the specific security that provides the standard for the contract. In some (but not many) cases, securities called for by a futures contract may not have been issued when the contract was written. Futures contracts on indexes of securities are settled through the making and acceptance of cash settlements based on changes in value of the underlying rate or index between the time the contract is entered into and the time it is liquidated. Stock Index Futures Contracts - The Portfolio may sell stock index futures contracts in order to offset a decrease in market value of its securities portfolio that might otherwise result from a market decline. The Portfolio may do so either to hedge the value of its portfolio as a whole, or to protect against declines, occurring prior to sales of securities, in the value of portfolio securities to be sold. Conversely, the Portfolio may purchase stock index futures contracts in order to protect against anticipated increases in the cost of securities to be acquired. As also described above with respect to futures contracts on fixed income securities and related indexes, in a substantial majority of these transactions, the Portfolio would purchase such securities upon termination of the long futures position, but under unusual market conditions, a long futures position may be terminated without a corresponding purchase of securities. In addition, the Portfolio may utilize stock index futures contracts in anticipation of changes in the composition of its portfolio. For example, in the event that the Portfolio expects to narrow the range of industry groups represented in its portfolio, the Portfolio may, prior to making purchases of the actual securities, establish a long futures position based on a more restricted index, such as an index comprised of -4- securities of a particular industry group. As such securities are acquired, the Portfolio's futures positions would be closed out. The Portfolio may also sell futures contracts in connection with this strategy, in order to protect against the possibility that the value of the securities to be sold as part of the restructuring of the Portfolio's portfolio will decline prior to the time of sale. Options on Stock Index Futures Contracts, Options on Stock Indexes and Options on Equity Securities - The Portfolio may purchase put options on stock index futures contracts, stock indexes or equity securities for the purpose of hedging the relevant portion of its securities portfolio against an anticipated market-wide decline or against declines in the values of individual portfolio securities, and the Portfolio may purchase call options on such futures contracts as a hedge against a market advance when it is not fully invested. The Portfolio would write options on such futures contracts primarily for the purpose of terminating existing positions. In general, options on stock indexes will be employed in lieu of options on stock index futures contracts only where they present an opportunity to hedge at lower cost. With respect to options on equity securities, the Portfolio may, under certain circumstances, purchase a combination of call options on such securities and U.S. Treasury bills. The Portfolio Adviser believes that such a combination may more closely parallel movements in the value of the security underlying the call option than would the option itself. Further, while the Portfolio generally would not write options on individual portfolio securities it may do so under limited circumstances known as "targeted sales" and "targeted buys", which involve the writing of call or put options in an attempt to purchase or sell portfolio securities at specific desired prices. The Portfolio would receive a fee, or a "premium", for the writing of the option. For example, where the Portfolio seeks to sell portfolio securities at a "targeted" price, it may write a call option at that price. In the event that the market rises above the exercise price, the Portfolio would receive its "targeted" price, upon the exercise of the option, as well as the premium income. Also, where the Portfolio seeks to buy portfolio securities at a "targeted" price, it may write a put option at that price for which it will receive the premium income. In the event that the market declines below the exercise price, the Portfolio would pay its "targeted" price upon the exercise of the option. In the event that the market does not move in the direction or to the extent anticipated, however, the targeted sale or buy might not be successful and the Portfolio could sustain a loss on the transaction which may not be offset by the premium received. In addition, the Portfolio may be required to forego the benefits of an intervening increase or decline in value of the underlying security. Risk Factors Associated with Futures and Options Transactions In addition to any risk factors which may be described above, the following sets forth certain information regarding the potential risks associated with the Portfolio's futures and options transactions. Risk of Imperfect Correlation - The Portfolio's ability effectively to hedge all or a portion of its portfolio through transactions in futures, options on futures or options on stock indexes depends on the degree to which movements in the value of the securities or index underlying such hedging instrument correlate with movements in the value of the relevant portion of the Portfolio's portfolio. If the values of the portfolio securities being hedged do not move in the same amount or direction as the underlying security or index, the hedging strategy for the Portfolio might not be successful and the Portfolio could sustain losses on its hedging transactions which would not be offset by gains on its portfolio. It is also possible that there may be a negative correlation between the security or index underlying a futures or option contract and the portfolio securities being hedged, which could result in losses both on the hedging transaction and the portfolio securities. In such instances, the Portfolio's overall return could be less than if the hedging transactions had not been undertaken. Stock index futures or options based on a narrower index of securities may present greater risk than options or futures based on a broad market index, as a narrower index is more susceptible to rapid and extreme fluctuations resulting from changes in the value of a small number of securities. The Portfolio would, however, effect transactions in such futures or options only for hedging purposes. The trading of futures and options on indexes involves the additional risk of imperfect correlation between movements in the futures or option price and the value of the underlying index. The anticipated spread between the prices may be distorted due to differences in the nature of the markets, such as -5- differences in margin requirements, the liquidity of such markets and the participation of speculators in the futures and options market. The purchase of an option on a futures contract also involves the risk that changes in the value of underlying futures contract will not be fully reflected in the value of the option purchased. The risk of imperfect correlation, however, generally tends to diminish as the maturity date of the futures contract or termination date of the option approaches. The risk incurred in purchasing an option on a futures contract is limited to the amount of the premium plus related transaction costs, although it may be necessary under certain circumstances to exercise the option and enter into the underlying futures contract in order to realize a profit. Under certain extreme market conditions, it is possible that the Portfolio will not be able to establish hedging positions, or that any hedging strategy adopted will be insufficient to completely protect the Portfolio. The Portfolio will purchase or sell futures contracts or options only if, in the Portfolio's Adviser's judgment, there is expected to be a sufficient degree of correlation between movements in the value of such instruments and changes in the value of the relevant portion of the Portfolio's portfolio for the hedge to be effective. There can be no assurance that the Portfolio Adviser's judgment will be accurate. Potential Lack of a Liquid Secondary Market - The ordinary spreads between prices in the cash and futures markets, due to differences in the natures of those markets, are subject to distortions. First, all participants in the futures market are subject to initial deposit and variation margin requirements. This could require the Portfolio to post additional cash or cash equivalents as the value of the position fluctuates. Further, rather than meeting additional variation margin requirements, investors may close futures contracts through offsetting transactions which could distort the normal relationship between the cash and futures markets. Second, the liquidity of the futures or options market may be lacking. Prior to exercise or expiration, a futures or option position may be terminated only by entering into a closing purchase or sale transaction, which requires a secondary market on the exchange on which the position was originally established. While the Portfolio will establish a futures or option position only if there appears to be a liquid secondary market therefor, there can be no assurance that such a market will exist for any particular futures or option contract at any specific time. In such event, it may not be possible to close out a position held by the Portfolio, which could require the Portfolio to purchase or sell the instrument underlying the position, make or receive a cash settlement, or meet ongoing variation margin requirements. The inability to close out futures or option positions also could have an adverse impact on the Portfolio's ability effectively to hedge its portfolio, or the relevant portion thereof. The liquidity of a secondary market in a futures contract or an option on a futures contract may be adversely affected by "daily price fluctuation limits" established by the exchanges, which limit the amount of fluctuation in the price of a contract during a single trading day and prohibit trading beyond such limits once they have been reached. The trading of futures and options contracts also is subject to the risk of trading halts, suspensions, exchange or clearing house equipment failures, government intervention, insolvency of the brokerage firm or clearing house or other disruptions of normal trading activity, which could at times make it difficult or impossible to liquidate existing positions or to recover excess variation margin payments. Trading and Position Limits - Each contract market on which futures and option contracts are traded has established a number of limitations governing the maximum number of positions which may be held by a trader, whether acting alone or in concert with others. The Portfolio Adviser does not believe that these trading and position limits will have an adverse impact on the hedging strategies regarding the Portfolio's portfolios. Restrictions on the Use of Futures and Option Contracts Regulations of the CFTC require that the Portfolio enters into transactions in futures contracts and options thereon for hedging purposes only, in order to assure that it is not deemed to be a "commodity pool" under such regulations. In particular, CFTC regulations require that all short futures positions be entered into for the purpose of hedging the value of securities held in the Portfolio's portfolio, and that all long futures positions either constitute bona fide hedging transactions, as defined in such regulations, or have a total value not in excess of an amount determined by reference to certain cash and securities positions maintained for the Portfolio, and accrued profits on such positions. In addition, the Portfolio may not purchase or sell such -6- instruments if, immediately thereafter, the sum of the amount of initial margin deposits on its existing futures positions and premiums paid for options on futures contracts would exceed 5% of the market value of the Portfolio's total assets. When the Portfolio purchases a futures contract, an amount of cash or cash equivalents or high quality debt securities will be deposited in a segregated account with the Portfolio's custodian so that the amount so segregated, plus the initial deposit and variation margin held in the account of its broker, will at all times equal the value of the futures contract, thereby insuring that the use of such futures is unleveraged. The Portfolio's ability to engage in the hedging transactions described herein may be limited by the current federal income tax requirement that the Portfolio derive less than 30% of its gross income from the sale or other disposition of stock or securities held for less than three months. In addition to the foregoing requirements, the Portfolio's Board of Trustees has adopted an additional restriction on the use of futures contracts and options thereon, requiring that the aggregate market value of the futures contracts held by the Portfolio not exceed 50% of the market value of its total assets. Neither this restriction nor any policy with respect to the above-referenced restrictions, would be changed by the Board of Trustees without considering the policies and concerns of the various federal and state regulatory agencies. Investment Restrictions In addition to the investment restrictions set forth below, the Fund has adopted the following investment restrictions to enable it to invest in the Portfolio: It is a fundamental policy of the Fund that because it holds no portfolio securities except interests in the Portfolio, the Fund's investment objective, policies and restrictions shall be identical to the Portfolio's investment objective, policies and restrictions, except for the following: the Fund (1) may invest more than 5% of its assets in another issuer, (2) may, consistent with Section 12 of the 1940 Act, invest in securities issued by other registered investment companies, (3) may invest more than 10% of its net assets in the securities of a registered investment company, (4) may hold more than 10% of the voting securities of a registered investment company, (5) will concentrate its investments in the investment company and (6) will not issue senior securities except as permitted by an exemptive order of the SEC. The Portfolio may not: (1) borrow money or pledge, mortgage or hypothecate its assets, except that, as a temporary measure for extraordinary or emergency purposes, it may borrow in an amount not to exceed 1/3 of the current value of its net assets, including the amount borrowed, and may pledge, mortgage or hypothecate not more than 1/3 of such assets to secure such borrowings (it is intended that, aside from reverse repurchase transactions, money would be borrowed by the Portfolio only from banks and only to accommodate requests for the repurchase of shares of the Portfolio while effecting an orderly liquidation of portfolio securities), provided that collateral arrangements with respect to the Portfolio's permissible futures and options transactions, including initial and variation margin, are not considered to be a pledge of assets for purposes of this restriction; the Portfolio will not purchase investment securities if its outstanding borrowing, including reverse repurchase agreements, exceeds 5% of the value of the Portfolio's total assets; (2) purchase any security or evidence of interest therein on margin, except that such short-term credit may be obtained as may be necessary for the clearance of purchases and sales of securities and except that, with respect to the -7- Portfolio's permissible options and futures transactions, deposits of initial and variation margin may be made in connection with the purchase, ownership, holding or sale of futures or options positions; (3) underwrite securities issued by other persons except insofar as the Portfolio may technically be deemed an underwriter under the Securities Act of 1933 in selling a portfolio security; (4) write, purchase or sell any put or call option or any combination thereof, provided that this shall not prevent (i) the purchase, ownership, holding or sale of warrants where the grantor of the warrants is the issuer of the underlying securities, (ii) the writing, purchasing or selling of puts, calls or combinations thereof with respect to U.S. Government securities or (iii) permissible futures and options transactions, the writing, purchasing, ownership, holding or selling of futures and options positions or of puts, calls or combinations thereof with respect to futures; (5) knowingly invest in securities which are subject to legal or contractual restrictions on resale (including securities that are not readily marketable, but not including repurchase agreements maturing in not more than seven days) if, as a result thereof, more than 10% of the Fund's or Portfolio's total assets (taken at market value) would be so invested (including repurchase agreements maturing in more than seven days); (6) purchase or sell real estate (including limited partnership interests but excluding securities secured by real estate or interests therein), interests in oil, gas or mineral leases, commodities or commodity contracts in the ordinary course of business, other than (i) permissible futures and options transactions or (ii) forward purchases and sales of foreign currencies or securities; (7) purchase securities of any issuer if such purchase at the time thereof would cause more than 10% of the voting securities of such issuer to be held by the Portfolio; (8) make short sales of securities or maintain a short position; except that the Portfolio may make such short sales of securities or maintain a short position if when a short position is open the Portfolio owns an equal amount of such securities or securities convertible into or exchangeable, without payment of any further consideration, for securities of the same issue as, and equal in amount to, the securities sold short, and unless not more than 10% of the Portfolio's net assets (taken at market value) is held as collateral for such sales at any one time (it is the present intention of management to make such sales only for the purpose of deferring realization of gain or loss for federal income tax purposes; such sales would not be made of securities subject to outstanding options); (9) concentrate its investments in any particular industry, but if it is deemed appropriate for the achievement of the Portfolio's investment objective, up to 25% of the assets of the Portfolio, at market value at the time of each investment, may be invested in any one industry, except that positions in options and futures shall not be subject to this restriction; or (10) issue any senior security (as that term is defined in the 1940 Act) if such issuance is specifically prohibited by the 1940 Act or the rules and -8- regulations promulgated thereunder, provided that collateral arrangements with respect to the Portfolio's permissible options and futures transactions, including deposits of initial and variation margin, are not considered to be the issuance of a senior security for purposes of this restriction. The Portfolio is not permitted to make loans to other persons, except (i) through the lending of its portfolio securities and provided that any such loans not exceed 30% of the Portfolio's total assets (taken at market value), (ii) through the use of repurchase agreements or the purchase of short-term obligations and provided that not more than 10% of the Portfolio's total assets will be invested in repurchase agreements maturing in more than seven days, or (iii) by purchasing, subject to the limitation in paragraph 5 above, a portion of an issue of debt securities of types commonly distributed privately to financial institutions, for which purposes the purchase of short-term commercial paper or a portion of an issue of debt securities which are part of an issue to the public shall not be considered the making of a loan. For purposes of the investment restrictions described above and the state and federal restrictions described below, the issuer of a tax-exempt security is deemed to be the entity (public or private) ultimately responsible for the payment of the principal of and interest on the security. For purposes of Investment Restriction No. 9, industrial development bonds, where the payment of principal and interest is the ultimate responsibility of companies within the same industry, are grouped together as an "industry". The Portfolio has also adopted the following non-fundamental investment policy which may be changed without shareholder approval. The Portfolio may enter into repurchase agreements (a purchase of and a simultaneous commitment to resell a security at an agreed-upon price on an agreed-upon date) only with member banks of the Federal Reserve System and securities dealers believed creditworthy and only if fully collateralized by U.S. Government obligations or other securities in which the Portfolio is permitted to invest. If the vendor of a repurchase agreement fails to pay the sum agreed to on the agreed-upon delivery date, the Portfolio would have the right to sell the securities constituting the collateral; however, the Portfolio might thereby incur a loss and in certain cases may not be permitted to sell such securities. Moreover, as noted above in paragraph 5, the Portfolio may not, as a matter of fundamental policy, invest more than 10% of its total assets in repurchase agreements maturing in more than seven days. The Portfolio has no current intention of engaging in the following activities in the foreseeable future: (i) writing, purchasing or selling puts, calls or combinations thereof with respect to U.S. Government securities; (ii) purchasing voting securities of any issuer. State and Federal Restrictions: In order to comply with certain federal and state statutes and regulatory policies, as a matter of operating policy, the Portfolio will not: (i) sell any security which it does not own unless by virtue of its ownership of other securities the Portfolio has at the time of sale a right to obtain securities, without payment of further consideration, equivalent in kind and amount to the securities sold and provided that if such right is conditional the sale is made upon the same conditions, (ii) invest for the purpose of exercising control or management, (iii) invest more than 5% of the Fund's assets in companies which, including predecessors, have a record of less than three years' continuous operation, (iv) invest in warrants valued at the lower of cost or market, in excess of 5% of the value of the Fund's net assets, and no more than 2% of such value may be warrants which are not listed on the New York or American Stock Exchanges, (v) purchase or retain in the Portfolio's portfolio any securities issued by an issuer any of whose officers, directors, trustees or security holders is an officer or trustee of the Portfolio, or is an officer or director of the Portfolio Adviser, if after the purchase of the securities of such issuer by the Portfolio one or more of such persons owns beneficially more than 1/2 of 1% of the shares or securities, or both, all taken at market value, of such issuer, and such persons owning more than 1/2 of 1% of such shares or securities together own beneficially more than 5% of such shares or securities, or both, all taken at market value, (vi) as to 50% of the Portfolio's total assets, purchase securities of any issuer if such purchase at the time thereof would cause the Portfolio to hold more than 10% of any class of securities of such issuer, for which purposes all indebtedness of an issuer shall be deemed a single class and all preferred stock of an issuer shall be deemed a single class. These policies are not fundamental and may be changed by the Portfolio's Board of Trustees without shareholder approval. -9- Percentage and Rating Restrictions: If a percentage or rating restriction on investment or utilization of assets set forth above or referred to in the Prospectus is adhered to at the time an investment is made or assets are so utilized, a later change in percentage resulting from changes in the value of the portfolio securities or a later change in the rating of a portfolio security of the Portfolio will not be considered a violation of policy. PORTFOLIO TRANSACTIONS Specific decisions to purchase or sell securities for the Portfolio are made by a portfolio manager who is an employee of the Portfolio Adviser and who is appointed and supervised by senior officers of the Portfolio Adviser. Changes in the Portfolio's investments are reviewed by the Board of Trustees. The Portfolio's portfolio manager may serve other clients of the Portfolio Adviser in a similar capacity. The frequency of the Portfolio's portfolio transactions, the portfolio turnover rate, will vary from year to year depending upon market conditions. Because a high turnover rate may increase transaction costs and the possibility of taxable short-term gains, the Portfolio Adviser will weigh the added costs of short-term investment against anticipated gains. The primary consideration in placing portfolio security transactions with broker-dealers for execution is to obtain and maintain the availability of execution at the most favorable prices and in the most effective manner possible. The Portfolio Adviser attempts to achieve this result by selecting broker-dealers to execute portfolio transactions on behalf of the Portfolio and other clients of the Portfolio Adviser on the basis of their professional capability, the value and quality of their brokerage services, and the level of their brokerage commissions. Debt securities are traded principally in the over-the-counter market through dealers acting on their own account and not as brokers. In the case of securities traded in the over-the-counter market (where no stated commissions are paid but the prices include a dealer's markup or markdown), the Portfolio Adviser normally seeks to deal directly with the primary market makers unless, in its opinion, best execution is available elsewhere. In the case of securities purchased from underwriters, the cost of such securities generally includes a fixed underwriting commission or concession. From time to time, soliciting dealer fees are available to the Portfolio Adviser on the tender of the Portfolio's portfolio securities in so-called tender or exchange offers. Such soliciting dealer fees are in effect recaptured for the Portfolios by the Portfolio Adviser. At present, no other recapture arrangements are in effect. Under Section 28(e) of the Securities Exchange Act of 1934, the Portfolio Adviser may cause the Portfolio to pay a broker-dealer which provides brokerage and research services to the Adviser an amount of commission for effecting a securities transaction for the Portfolio in excess of the amount other broker-dealers would have charged for the transaction if the Portfolio Adviser determines in good faith that the greater commission is reasonable in relation to the value of the brokerage and research services provided by the executing broker-dealer viewed in terms of either a particular transaction or the Portfolio Adviser's overall responsibilities to the Portfolio or to its clients. Not all of such services are useful or of value in advising the Portfolio. The term "brokerage and research services" includes advice as to the value of securities, the advisability of investing in, purchasing or selling securities, and the availability of securities or of purchasers or sellers of securities, furnishing analyses and reports concerning issues, industries, securities, economic factors and trends, portfolio strategy and the performance of accounts, and effecting securities transactions and performing functions incidental thereto such as clearance and settlement. Although commissions paid on every transaction will, in the judgment of the Portfolio Adviser, be reasonable in relation to the value of the brokerage services provided, commissions exceeding those which another broker might charge may be paid to broker-dealers who were selected to execute transactions on behalf of the Portfolio and the Portfolio Adviser's other clients as part of providing advice as to the availability of -10- securities or of purchasers or sellers of securities and services in effecting securities transactions and performing functions incidental thereto, such as clearance and settlement. Broker-dealers may be willing to furnish statistical, research and other factual information or services ("Research") to the Portfolio Adviser for no consideration other than brokerage or underwriting commissions. Securities may be bought or sold through such broker-dealers, but at present, unless otherwise directed by the Portfolio, a commission higher than one charged elsewhere will not be paid to such a firm solely because it provided Research to the Portfolio Adviser. The Portfolio Adviser's investment management personnel will attempt to evaluate the quality of Research provided by brokers. Results of this effort are sometimes used by the Portfolio Adviser as a consideration in the selection of brokers to execute portfolio transactions. However, the Portfolio Adviser would be unable to quantify the amount of commissions which are paid as a result of such Research because a substantial number of transactions are effected through brokers which provide Research but which are selected principally because of their execution capabilities. The advisory fees that the Funds pay to the Portfolio Adviser will not be reduced as a consequence of the Adviser's receipt of brokerage and research services. To the extent the Portfolio's portfolio transactions are used to obtain such services, the brokerage commissions paid by the Portfolio will exceed those that might otherwise be paid, by an amount which cannot be presently determined. Such services would be useful and of value to the Portfolio Adviser in serving the Portfolio and other clients and, conversely, such services obtained by the placement of brokerage business of other clients would be useful to the Portfolio Adviser in carrying out its obligations to the Portfolio. While such services are not expected to reduce the expenses of the Portfolio Adviser, the Portfolio Adviser would, through use of the services, avoid the additional expenses which would be incurred if it should attempt to develop comparable information through its own staff. In certain instances, there may be securities that are suitable for the Portfolio as well as one or more of the Portfolio Adviser's other clients. Investment decisions for the Portfolio and for the Portfolio Adviser's other clients are made with a view to achieving their respective investment objectives. It may develop that the same investment decision is made for more than one client or that a particular security is bought or sold for only one client even though it might be held by, or bought or sold for, other clients. Likewise, a particular security may be bought for one or more clients when one or more clients are selling that same security. Some simultaneous transactions are inevitable when several clients receive investment advice from the same investment adviser, particularly when the same security is suitable for the investment objectives of more than one client. When the Portfolio or the Portfolio Adviser's other clients are simultaneously engaged in the purchase or sale of the same security, the securities are allocated among clients in a manner believed to be equitable to each. It is recognized that in some cases this system could have a detrimental effect on the price or volume of the security as far as the Portfolio is concerned. However, it is believed that the ability of the Portfolio to participate in volume transactions will generally produce better executions for the Portfolio. COMPUTATION OF NET ASSET VALUE The net asset value of the FUND is determined at 4:15 p.m. New York time, on each day that the New York Stock Exchange is open for business and on such other days as there is sufficient trading in the FUND's securities to affect materially the net asset value per share of the FUND. The FUND will be closed on New Years Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day. The Portfolio will invest in foreign securities, and as a result, the calculation of the FUND's net asset value may not take place contemporaneously with the determination of the prices of certain of the portfolio securities used in the calculation. Occasionally, events which affect the values of such securities and such exchange rates may occur between the times at which they are determined and the close of the New York Stock Exchange and will therefore not be reflected in the computation of the FUND's net asset value. If events -11- materially affecting the value of such securities occur during such period, then these securities will be valued at their fair value as determined in good faith under procedures established by and under the supervision of the Trustees of the Portfolio. Portfolio securities which are traded both on an exchange and in the over-the-counter market, will be valued according to the broadest and most representative market. All assets and liabilities initially expressed in foreign currency values will be converted into U.S. Dollar values at the mean between the bid and offered quotations of the currencies against U.S. Dollars as last quoted by any recognized dealer. When portfolio securities are traded, the valuation will be the last reported sale price on the day of valuation. (For securities traded on the New York Stock Exchange, the valuation will be the last reported sales price as of the close of the Exchange's regular trading session, currently 4:00 p.m. New York Time.) If there is no such reported sale or the valuation is based on the Over-the-Counter market, the securities will be valued at the last available bid price or at the mean between the bid and asked prices, as determined by the Trustees. As of the date of this Statement of Additional Information, such securities will be valued by the latter method. Securities for which reliable quotations are not readily available and all other assets will be valued at their respective fair market value as determined in good faith by, or under procedures established by, the Trustees of the Portfolio. Money market instruments with less than sixty days remaining to maturity when acquired by the Portfolio will be valued on an amortized cost basis by the Portfolio, excluding unrealized gains or losses thereon from the valuation. This is accomplished by valuing the security at cost and then assuming a constant amortization to maturity of any premium or discount. If the Portfolio acquires a money market instrument with more than sixty days remaining to its maturity, it will be valued at current market value until the 60th day prior to maturity, and will then be valued on an amortized cost basis based upon the value on such date unless the Trustees of the Portfolio determine during such 60-day period that this amortized cost value does not represent fair market value. All liabilities incurred or accrued are deducted from the FUND's total assets. The resulting net assets are divided by the number of shares of the FUND outstanding at the time of the valuation and the result (adjusted to the nearest cent) is the net asset value per share. Orders to purchase or redeem shares of the Fund received by dealers prior to 4:15 P.M. (New York Time) will be confirmed at the previous offering or redemption price computed as of the close of trading on the options exchanges (normally 4:15 P.M., New York Time), provided the order is received by the FUND's Transfer Agent prior to 4:15 P.M. on that day. It is the responsibility of the dealer to insure that all orders are transmitted timely to the FUND. Orders received by dealers after 4:15 P.M. will be confirmed at the next computed offering or redemption price. PERFORMANCE INFORMATION For purposes of quoting and comparing the performance of the FUND to that of other mutual funds and to stock or other relevant indices in advertisements or in reports to Shareholders, performance will be stated both in terms of total return and in terms of yield. The total return basis combines principal and dividend income changes for the periods shown. Principal changes are based on the difference between the beginning and closing net asset values for the period and assume reinvestment of dividends and distributions paid by the FUND. Dividends and distributions are comprised of net investment income and net realized capital gains. Under the rules of the Commission, funds advertising performance must include total return quotes calculated according to the following formula: P(1 + T)n = ERV Where P = a hypothetical initial payment of $1,000 T = average annual total return n = number of years (1, 5 or 10) -12- ERV = ending redeemable value of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods or at the end of the 1, 5 or 10 year periods (or fractional portion thereof) Under the foregoing formula the time periods used in advertising will be based on rolling calendar quarters, updated to the last day of the most recent quarter prior to submission of the advertising for publication, and will cover one, five, and ten year periods or a shorter period dating from the effectiveness of the FUND's registration statement. In calculating the ending redeemable value, the pro rata share of the account opening fee is deducted from the initial $1,000 investment and all dividends and distributions by the FUND are assumed to have been reinvested at net asset value as described in the prospectus on the reinvestment dates during the period. Total return, or "T" in the formula above, is computed by finding the average annual compounded rates of return over the 1, 5 and 10 year periods (or fractional portion thereof) that would equate the initial amount invested to the ending redeemable value. The FUND's aggregate annualized total rate of return, reflecting the initial investment and reinvestment of all dividends and distributions for the period ended February 28, 1995 was 19.34%. The FUND may also from time to time include in such advertising a total return figure that is not calculated according to the formula set forth above in order to compare more accurately the FUND's performance with other measures of investment return. For example, in comparing the FUND's total return with data published by Lipper Analytical Services, Inc. or similar independent services or financial publications, the FUND calculates its aggregate total return for the specified periods of time by assuming the reinvestment of each dividend or other distribution at net asset value on the reinvestment date. Percentage increases are determined by subtracting the initial net asset value of the investment from the ending net asset value and by dividing the remainder by the beginning net asset value. The FUND does not, for these purposes, deduct the pro rata share of the account opening fee, which was in effect until December 1994, from the initial value invested. The FUND will, however, disclose the pro rata share of the account opening fee and will disclose that the performance data does not reflect such non-recurring charge and that inclusion of such charge would reduce the performance quoted. Such alternative total return information will be given no greater prominence in such advertising than the information prescribed under the Commission's rules. ADDITIONAL PURCHASE AND REDEMPTION INFORMATION The FUND reserves the right to close an account that has dropped below $1,000 in value for a period of three months or longer other than as a result of a decline in the net asset value per share. Shareholders are notified at least 60 days prior to any proposed redemption and are invited to add to their account if they wish to continue as shareholders of the FUND, however, the FUND does not presently contemplate making such redemptions and the FUND will not redeem any shares held in tax-sheltered retirement plans. The FUND has elected to be governed by Rule 18f-1 of the 1940 Act, under which the FUND is obligated to redeem the shares of any shareholder solely in cash up to the lesser of 1% of the net asset value of the FUND or $250,000 during any 90-day period. Should any shareholder's redemption exceed this limitation, the FUND can, at its sole option, redeem the excess in cash or in portfolio securities. Such securities would be selected solely by the FUND and valued as in computing net asset value. In these circumstances a shareholder selling such securities would probably incur a brokerage charge and there can be no assurance that the price realized by a shareholder upon the sale of such securities will not be less than the value used in computing net asset value for the purpose of such redemption. -13- TAX MATTERS The following is only a summary of certain additional tax considerations generally affecting the FUND and its shareholders that are not described in the Prospectus. No attempt is made to present a detailed explanation of the tax treatment of the FUND or its shareholders, and the discussions here and in the Prospectus are not intended as substitutes for careful tax planning. Qualification as a Regulated Investment Company The FUND has elected to be taxed as a regulated investment company ("RIC") under Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a RIC, the FUND is not subject to federal income tax on the portion of its net investment income (i.e., taxable interest, dividends and other taxable ordinary income, net of expenses) and capital gain net income (i.e., the excess of capital gains over capital losses) that it distributes to shareholders, provided that it distributes at least 90% of its investment company taxable income (i.e., net investment income and the excess of net short-term capital gain over net long-term capital loss) for the taxable year (the "Distribution Requirement"), and satisfies certain other requirements of the Code that are described below. Distributions by the FUND made during the taxable year or, under specified circumstances, within twelve months after the close of the taxable year, will be considered distributions of income and gains of the taxable year and can therefore satisfy the Distribution Requirement. Because the FUND invests all of its assets in the Portfolio, which is classified as a partnership for federal income tax purposes, the FUND will be deemed to own a proportionate share of the assets and income of the Portfolio for purposes of determining whether the FUND satisfies the requirements (described more fully below) necessary to qualify as a regulated investment company. In addition to satisfying the Distribution Requirement, a RIC must: (1) derive at least 90% of its gross income from dividends, interest, certain payments with respect to securities loans, gains from the sale or other disposition of stock or securities or foreign currencies (to the extent such currency gains are directly related to the company's principal business of investing in stock or securities) and other income (including gains from options, futures or forward contracts) derived with respect to its business of investing in such stock, securities or currencies (the "Income Requirement"); and (2) derive less than 30% of its gross income (exclusive of certain gains on designated hedging transactions that are offset by realized or unrealized losses on offsetting positions) from the sale or other disposition of stock, securities or foreign currencies (or options, futures or forward contracts thereon) held for less than three months (the "Short-Short Gain Test"). Because of the Short-Short Gain Test, the FUND may have to limit the sale of appreciated securities that it held for less than three months. However, foreign currency gains that are directly related to the company's investment in stock or securities are not treated as short-short gains. Similarly, the Short-Short Gain Test will not prevent the FUND from disposing of investments at a loss, since losses are disregarded for this purpose. Interest (including original issue discount) received by the FUND at maturity or upon the disposition of a security held for less than three months is not treated as gross income derived from the sale or other disposition of a security within the meaning of the Short-Short Gain Test. However, income attributable to realized market appreciation will be so treated for this purpose. In general, gain or loss recognized by the Portfolio on the disposition of an asset (and allocated to the Fund) will be a capital gain or loss. However, gain recognized on the disposition of a debt obligation purchased at a market discount will be treated as ordinary income to the extent of the portion of the discount that accrued while the Portfolio held the obligation. In addition, under the rules of Code Section 988, a portion of gain or loss recognized on the disposition of a debt obligation denominated in a foreign currency or an option with respect thereto, and (with certain exceptions) gain or loss recognized on the disposition of a foreign currency forward contract, futures contract, option or similar financial instrument, or of foreign currency itself, will generally be treated as ordinary income or loss. In general, for purposes of determining whether capital gain or loss recognized by the FUND (through its Portfolio) on the disposition of an asset is long-term or short-term, the holding period of the asset -14- may be affected if (1) the asset is used to close a "short sale" (which may include the acquisition of a put option) or is substantially identical to another asset so used, (2) the asset is otherwise held by the Portfolio as part of a "straddle" (as defined) or (3) the asset is stock and the Portfolio grants an in-the-money qualified covered call option with respect thereto. In addition, the FUND may be required to defer the recognition of a loss on a disposition of an asset held as part of a straddle to the extent of any unrecognized gain on the offsetting position. Any gain allocated to the FUND on the lapse of, or any gain or loss allocated to it from a closing transaction with respect to, an option written by the Portfolio will be treated as a short-term capital gain or loss. For purposes of the Short-Short Gain Test, the holding period of such an option will commence on the date it is written and end on the date it lapses or the date a closing transaction is entered into. Accordingly, the Portfolio may be limited in its ability to write options which expire within three months and to enter into closing transactions at a gain within three months of the writing of options. Regulated futures contracts, certain foreign currency contracts, and options on stock indexes and futures contracts are subject to special tax treatment as "Section 1256 contracts." Such contracts are treated as if they are sold for their fair market value on the last business day of the taxable year, even though a taxpayer's obligations (or rights) under such contracts have not terminated as of such date. Gain or loss recognized as a consequence of the year-end deemed disposition of Section 1256 contracts is taken into account for the taxable year together with any gain or loss recognized upon the actual termination of such contracts during the year. The combined capital gain or loss for the year with respect to Section 1256 contracts is generally treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. (The Portfolio may elect not to have this special tax treatment apply to Section 1256 contracts that are part of a "mixed straddle" with other investments that are not Section 1256 contracts.) The IRS has held in private rulings that constructive gains arising from deemed year-end dispositions of Section 1256 contracts will not be taken into account for purposes of the Short-Short Gain Test. Treasury Regulations permit a regulated investment company, in determining its investment company taxable income and net capital gain (i.e., the excess of net long-term capital gain over net short-term capital loss) for any taxable year, to elect (unless it has made a taxable year election for excise tax purposes as discussed below) to treat all or any part of any net capital loss, any net long-term capital loss or any net foreign currency loss incurred after October 31 as if it were incurred in the succeeding year. In addition to the requirements described above, the FUND must satisfy an asset diversification test in order to qualify as a regulated investment company. Under this test, at the close of each quarter of a RIC's taxable year, at least 50% of the value of its assets must consist of cash and cash items, U.S. Government securities, securities of other RICs, and securities of other issuers (as to which the RIC has not invested more than 5% of the value of its total assets in securities of such issuer and as to which it does not hold more than 10% of the outstanding voting securities of such issuer), and no more than 25% of the value of its total assets may be invested in the securities of any one issuer (other than U.S. Government securities and securities of other RICs), or in two or more issuers which the RIC controls and which are engaged in the same or similar trades or businesses. Generally, an option (call or put) with respect to a security is treated as issued by the issuer of the security and not the issuer of the option. If for any taxable year the FUND does not qualify as a RIC, all of its taxable income (including its net capital gain) will be subject to tax at regular corporate rates without any deduction for distributions to shareholders, and such distributions will be taxable to the shareholders as ordinary dividends to the extent of the FUND's current and accumulated earnings and profits. Such distributions generally will be eligible for the dividends-received deduction in the case of corporate shareholders. -15- Excise Tax on Regulated Investment Companies A 4% non-deductible excise tax is imposed on a RIC that fails to distribute in each calendar year an amount equal to 98% of its ordinary taxable income for the calendar year and 98% of its capital gain net income for the one-year period ended on October 31 of the year. The balance of such income must be distributed during the next calendar year. The FUND intends to make sufficient distributions or deemed distributions of its ordinary taxable income and capital gain net income prior to the end of each calendar year to avoid liability for the excise tax. The FUND may in certain circumstances have to liquidate portfolio investments in order to effect such distributions. FUND Distributions The FUND intends to distribute substantially all of its investment company taxable income for each taxable year. Such distributions will be taxable to shareholders as ordinary income and treated as dividends for federal income tax purposes, but will qualify for the 70% dividends-received deduction for corporate shareholders only to the extent discussed below. The FUND may either retain or distribute to shareholders its net capital gain for each taxable year. The FUND currently intends to distribute such gains annually. Net capital gain distributed and designated as a capital gain dividend is taxable to shareholders as long-term capital gain, regardless of the shareholder's holding period in his shares and the time when such gain was recognized by the Portfolio. If the FUND elects to retain its net capital gain, it will be taxed thereon (except to the extent of any available capital loss carryovers) at the 35% corporate tax rate. In this case, the FUND would expect to elect to have shareholders of record on the last day of the taxable year treated as if each received a distribution of his pro rata share of the gain, with the result that each would be required to report his pro rata share of such gain on his tax return as a long-term capital gain, would receive a refundable tax credit for his pro rata share of the tax paid by the FUND on the gain, and would increase the tax basis for his shares by an amount equal to the deemed distribution less the credit. Ordinary income dividends distributed by the FUND will qualify for the 70% dividends-received deduction generally available to corporations (other than corporations, such as S corporations, which are not eligible for the deduction) to the extent of the portion of the distribution attributed to "qualifying dividends" received by the Portfolio during the taxable year from domestic corporations. A dividend received by the Portfolio will not be treated as a qualifying dividend (1) if it was received with respect to stock that the Portfolio held for less than 46 days (91 days in the case of certain preferred stock), subject to the limitations of Code Sections 246(c)(3) and (4) and 246A. Moreover, the dividends-received deduction for a corporate shareholder will also be disallowed if the corporate shareholder fails to satisfy the foregoing requirements with respect to its FUND shares or the FUND fails to satisfy them with respect to its interest in the Portfolio. Investment income that may be received by the Portfolio from foreign sources may be subject to foreign taxes withheld at the source. The United States has entered into tax treaties with a number of foreign countries, which entitle the Portfolio to reduced rates of, or exemptions from, taxes on such income. It is impossible to determine the effective rate of foreign tax in advance since the future mix of the Portfolio's investment in various countries is not known. Distributions by the FUND that do not constitute ordinary income dividends or capital gain dividends will be treated as a return of capital to the extent of (and in reduction of) the shareholders' tax basis in their shares; any excess will be treated as gain from a sale of the shares, as discussed more fully below. -16- Distributions by the FUND will be treated in the manner described above whether they are paid in cash or reinvested in additional shares of the FUND (or of another fund). In addition, if a shareholder's cost for his shares already reflects undistributed (realized or unrealized) income or gain, a subsequent distribution of such amounts will be taxable to the shareholder in the manner described above, although economically it constitutes a return of capital. Ordinarily, shareholders are required to take distributions into account in the year in which they are made. However, dividends declared by the Fund in October, November or December of any calendar year and payable to shareholders of record on a specified date in such a month will be deemed to have been received by the shareholders (and made by the FUND) on December 31 of such year if such dividends are actually paid in January of the following year. Shareholders will be advised annually as to the U.S. federal income tax consequences of distributions made (or deemed made) during the year. The FUND will be required in certain cases to withhold and remit to the U.S. Treasury 31% of dividends and the proceeds of redemption paid to any shareholder (1) who has provided either an incorrect tax identification number or no number at all to the Fund, (2) who is subject to backup withholding pursuant to a notice from the IRS for failure to report interest or dividend income properly, or (3) who has not otherwise certified to the FUND that it is not subject to backup withholding. Sale or Redemption of Shares A shareholder will recognize gain or loss on the sale or redemption of his shares in an amount equal to the difference between the amount realized on the shares and his adjusted tax basis in them. All or a portion of any loss so recognized may be disallowed if the shareholder purchases other shares of the FUND within 30 days before or after the disposition. In general, gain or loss arising from a sale or redemption of FUND shares will constitute capital gain or loss, and will be long-term capital gain or loss if the shares were held longer than one year. However, a capital loss arising from a disposition of shares held for six months or less will be treated as a long-term capital loss to the extent of any amount of capital gain dividends received on the shares. For this purpose, the special holding period rules of Code Section 246(c)(3) and (4) (alluded to above in connection with the dividends-received deduction for corporations) will generally apply. Capital losses in any year are deductible only to the extent of capital gains plus, in the case of noncorporate taxpayers, $3,000 of ordinary income. Foreign Shareholders Taxation of a shareholder who, as to the United States, is a nonresident alien individual, foreign trust or estate, foreign corporation, or foreign partnership ("foreign shareholder"), depends on whether the income received from the FUND is "effectively connected" with a U.S. trade or business carried on by the shareholder. If the income is not effectively connected in the above sense, ordinary income dividends distributed to a foreign shareholder will be subject to U.S. withholding tax at the rate of 30% (or a lower treaty rate, if one applies) of the gross amount of the dividend. Such a shareholder would generally be exempt from U.S. federal income tax on gains realized on a sale of FUND shares and capital gain dividends. If income from the FUND is effectively connected with a U.S. trade or business carried on by a foreign shareholder, then ordinary income dividends, capital gain dividends, and gain realized upon the sale of FUND shares will be subject to U.S. federal income tax at the rates applicable to U.S. citizens or domestic corporations. -17- In the case of foreign noncorporate shareholders, the FUND may be required to withhold U.S. federal income tax at a rate of 31% on distributions that are otherwise exempt from withholding tax (or taxable at a reduced treaty rate) unless they furnish the FUND with proper notification of their exempt status. The tax consequences to foreign shareholders entitled to claim the benefits of applicable treaties may differ from one treaty to another. Foreign shareholders are urged to consult their own tax advisers with respect to the particular tax consequences to them of an investment in the FUND, including the applicability of any foreign taxes. Effect of Future Legislation; Local Tax Considerations The foregoing general discussion of U.S. federal income tax consequences is based on the Code and the Treasury Regulations as in effect on the date of this Statement of Additional Information. Future legislative or administrative changes or court decisions may significantly alter the conclusions expressed herein, perhaps with retroactive effect. Rules of state and local taxation of dividends from regulated investment companies often differ from the rules for U.S. federal income taxation described above. Shareholders are urged to consult their tax advisers as to the consequences of their investing in the FUND in light of their particular circumstances. THE MANAGEMENT OF THE FUND Officers and Trustees are listed with their ages, addresses, principal occupations, and present positions, including any affiliation with Virtus Capital Management, Inc., Signet Trust Company, Federated Investors, Federated Securities Corp., Federated Services Company, and Federated Administrative Services or the Funds (as defined below). John F. Donahue, 70 (1)(2) Federated Investors Tower Pittsburgh, PA Chairman and Trustee of the Fund; Chairman and Director of Blanchard Precious Metals Fund, Inc.; Chairman and Trustee of The Virtus Funds; Chairman and Trustee, Federated Investors, Federated Advisers, Federated Management, and Federated Research; Chairman and Director, Federated Research Corp.; Chairman, Passport Research, Ltd.; Director, AEtna Life and Casualty Company; Chief Executive Officer and Director, Trustee, or Managing General Partner of the Funds. Thomas G. Bigley, 61 28th Floor One Oxford Centre Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director, Oberg Manufacturing Co.; Chairman of the Board, Children's Hospital of Pittsburgh; Director, Trustee or Managing General Partner of the Funds; formerly, Senior Partner, Ernst & Young LLP.
-18- John T. Conroy, Jr., 57 (3) Wood/IPC Commercial Department John R. Wood and Associates, Inc., Realtors 3255 Tamiami Trail North Naples, FL Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; President, Investment Properties Corporation; Senior Vice-President, John R. Wood and Associates, Inc., Realtors; President, Northgate Village Development Corporation; Partner or Trustee in private real estate ventures in Southwest Florida; Director, Trustee, or Managing General Partner of the Funds; formerly, President, Naples Property Management, Inc. William J. Copeland, 76 (3) One PNC Plaza - 23rd Floor Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Director and Member of the Executive Committee, Michael Baker, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman and Director, PNC Bank, N.A., and PNC Bank Corp. and Director, Ryan Homes, Inc. James E. Dowd, 72 (3) 571 Hayward Mill Road Concord, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Director, The Emerging Germany Fund, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Director, Blue Cross of Massachusetts, Inc. Lawrence D. Ellis, M.D., 62 (1) 3471 Fifth Avenue, Suite 1111 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Hematologist, Oncologist, and Internist, Presbyterian and Montefiore Hospitals; Professor of Medicine and Member, Board of Trustees, University of Pittsburgh; Medical Director, University of Pittsburgh Medical Center--Downtown, Member, Board of Directors, University of Pittsburgh Medical Center; Director, Trustee, or Managing General Partner of the Funds. Edward L. Flaherty, Jr., 70 (1)(3) Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The
-19- Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Director, Eat'N Park Restaurants, Inc., and Statewide Settlement Agency, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Counsel, Horizon Financial, F.A., Western Region. Edward C. Gonzales, 64 (1) Federated Investors Tower Pittsburgh, PA President, Trustee and Treasurer of the Fund; President, Director and Treasurer of Blanchard Precious Metals Fund, Inc.; President, Trustee and Treasurer of The Virtus Funds; Vice President, Treasurer, and Trustee, Federated Investors; Vice President and Treasurer, Federated Advisers, Federated Management, Federated Research, Federated Research Corp., and Passport Research, Ltd.; Executive Vice President, Treasurer, and Director, Federated Securities Corp.; Trustee, Federated Services Company and Federated Shareholder Services; Chairman, Treasurer, and Trustee, Federated Administrative Services; Trustee or Director of some of the Funds; Vice President and Treasurer of the Funds. Peter E. Madden, 53 225 Franklin Street Boston, MA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Consultant; State Representative, Commonwealth of Massachusetts; Director, Trustee, or Managing General Partner of the Funds; formerly, President, State Street Bank and Trust Company and State Street Boston Corporation and Trustee, Lahey Clinic Foundation, Inc. Gregor F. Meyer, 68 Two Gateway Center - Suite 674 Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Attorney-at-law; Partner, Henny, Kochuba, Meyer & Flaherty; Chairman, Meritcare, Inc.; Director, Eat'N Park Restaurants, Inc.; Director, Trustee, or Managing General Partner of the Funds; formerly, Vice Chairman, Horizon Financial, F.A. John E. Murray, Jr., J.D., S.J.D., 62 Duquesne University Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The
-20- Virtus Funds; President, Law Professor, Duquesne University; Consulting Partner, Mollica, Murray and Hogue; Director, Trustee or Managing Partner of the Funds. Wesley W. Posvar, 69 1202 Cathedral of Learning University of Pittsburgh Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Professor, Foreign Policy and Management Consultant; Trustee, Carnegie Endowment for International Peace, RAND Corporation, Online Computer Library Center, Inc., and U.S. Space Foundation; Chairman, Czecho Slovak Management Center; Director, Trustee, or Managing General Partner of the Funds; President Emeritus, University of Pittsburgh; formerly, Chairman, National Advisory Council for Environmental Policy and Technology. Marjorie P. Smuts, 59 4905 Bayard Street Pittsburgh, PA Trustee of the Fund; Director of Blanchard Precious Metals Fund, Inc.; Trustee of The Virtus Funds; Public relations/marketing consultant; Director, Trustee, or Managing General Partner of the Funds. - --------------- (1) This Trustee is deemed to be an "interested person" of the Trust as defined in the Investment Company Act of 1940, as amended. (2) Member of the Executive Committee. The Executive Committee of the Board of Trustees handles the responsibilities of the Board of Trustees between meetings of the Board. (3) Member of the Audit Committee. The Audit Committee is responsible for reviewing compliance with all internal controls and all regulations related to the financial reporting process.
The Funds As referred to in the list of Trustees and Officers, "Funds" includes the following investment companies: American Leaders Fund, Inc.; Annuity Management Series; Arrow Funds; Automated Cash Management Trust; Automated Government Money Trust; California Municipal Cash Trust; Cash Trust Series II; Cash Trust Series, Inc.; DG Investor Series; Edward D. Jones & Co. Daily Passport Cash Trust; Federated ARMs Fund; Federated Exchange Fund, Ltd.; Federated GNMA Trust; Federated Government Trust; Federated Growth Trust; Federated High Yield Trust; Federated Income Securities Trust; Federated Income Trust; Federated Index Trust; Federated Institutional -21- Trust; Federated Master Trust; Federated Municipal Trust; Federated Short-Term Municipal Trust; Federated Short-Term U.S. Government Trust; Federated Stock Trust; Federated Tax-Free Trust; Federated Total Return Series, Inc.; Federated U.S. Government Bond Fund; Federated U.S. Government Securities Fund: 1-3 years; Federated U.S. Government Securities Fund: 3-5 years; First Priority Funds; Fixed Income Securities, Inc.; Fortress Adjustable Rate U.S. Government Fund, Inc.; Fortress Municipal Income Fund, Inc.; Fortress Utility Fund, Inc.; Fund for U.S. Government Securities, Inc.; Government Income Securities, Inc,; High Yield Cash Trust; Insurance Management Series; Intermediate Municipal Trust: International Series, Inc.; Investment Series Funds, Inc.; Investment Series Trust; Liberty Equity Income Fund, Inc.; Liberty High Income Bond Fund, Inc.; Liberty Municipal Securities Fund, Inc.; Liberty U.S. Government Money Market Trust; Liberty Term Trust, Inc.-1999; Liberty Utility Fund, Inc.; Liquid Cash Trust; Managed Series Trust; Money Market Management, Inc.; Money Market Obligations Trust; Money Market Trust; Municipal Securities Income Trust; Newpoint Funds; New York Municipal Cash Trust; 111 Corcoran Funds; Peachtree Funds; The Planters Funds; RIMCO Monument Funds; The Shawmut Funds; Short-Term Municipal Trust; Star Funds; The Starburst Funds; The Starburst Funds II; Stock and Bond Fund, Inc.; Sunburst Funds; Targeted Duration Trust; Tax-Free Instruments Trust; Trademark Funds; Trust for Financial Institutions; Trust For Government Cash Reserves; Trust for Short-Term U.S. Government Securities; Trust for U.S. Treasury Obligation; The Virtus Funds; and World Investment Series, Inc. Fund Ownership As of June 30, 1995, Officers and Trustees own less than 1% of the outstanding shares of each Fund. To the best knowledge of the FUND, as of June 30, 1995, no shareholder owned 5% or more of the outstanding shares of the FUND. The Trustees and officers of the Portfolio and their principal occupations for at least the past five years are set forth below. Their titles may have varied during that period. Asterisks indicate those Trustees who are "interested persons" (as defined in the 1940 Act) of the Portfolio. Unless otherwise indicated below, the address of each officer is 6 St. James Avenue, Suite 900, Boston, Massachusetts 02116. Stuart W. Cragin, Jr. Trustee, Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, 108 Valley Road International Equity Portfolio, Mutual Fund Greenwich, CT 06870 Group, Mutual Fund Trust and Mutual Fund Variable Annuity Trust; President, Fairfield Testing Laboratory, Inc. (laboratory providing materials testing), since 1989; prior to 1989 he served in a variety of positions with Union Camp Corporation, Trinity Paper & Plastics Corp., and Conover Industries, Inc. Irv Thode Trustee, Growth and Income Portfolio, Capital Growth Trustee Portfolio, Capital Growth Global Fixed Income Portfolio, 80 Perkins Road International Equity Portfolio, Mutual Fund Group, Mutual Greenwich, CT 06830 Fund Trust and Mutual Fund Variable Annuity Trust; Retired; Vice President, Eastern Region Sales, Quotron Systems; 1983 through 1990 has held numerous executive positions with Control Data Corporation including President of Latin American operations and General Manager of its Data Services business.
-22- H. Richard Vartabedian* Trustee and Chairman, Growth and Income Portfolio, Chairman Capital Growth Portfolio, Global Fixed Income P.O. Box 296 Portfolio, International Equity Portfolio; Trustee, Mutual Beach Road Fund Group, Mutual Fund Trust and Mutual Fund Variable Hendrick's Head Annuity Trust; Retired; Former Senior Investment Officer, Southport, Maine 04576 Division Executive of the Investment Management Division of The Chase Manhattan Bank, N.A., 1980 through 1991. Fergus Reid, III* Trustee, Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, International 971 West Road Equity Portfolio; Trustee and Chairman, Mutual Fund New Canaan, CT 06840 Group, Mutual Fund Trust and Mutual Fund Variable Annuity Trust; Chairman and Chief Executive Officer, Lumelite Corporation, since September, 1985. Joseph Harkins* Retired; Trustee, Growth and Income Portfolio, Capital Trustee Growth Portfolio, Global Fixed Income Portfolio, 257 Plantation Circle South International Equity Portfolio, Mutual Fund Group, Mutual Ponte Vedra Beach, FL 32082 Fund Trust and Mutual Fund Variable Annuity Trust; Commercial Sector Executive and Executive Vice President of The Chase Manhattan Bank, N.A. from 1985 through 1989; Director of Blessing Corporation and Jefferson Insurance Company of New York, Monticello Insurance Company. Richard E. Ten Haken Trustee of Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income International Equity 4 Barnfield Road Portfolio, Mutual Fund Group, Mutual Fund Trust and Pittsford, New York 14534 Mutual Fund Variable Annuity Trust; District Superintendent of Schools, Monroe No. 2 and Orleans Counties, New York; Chairman of the Finance and Audit and Accounting Committees, Member of the Executive Committee and Vice President, New York State Teachers' Retirement System. William J. Armstrong Trustee of Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, International 49 Aspen Way Equity Portfolio, Mutual Fund Group, Mutual Fund Upper Saddle River, NJ 07458 Trust and Mutual Fund Variable Annuity Trust; Vice President and Treasurer, Ingersoll-Rand Company (Woodcliff Lake, New Jersey). John R.H. Blum Trustee of Growth and Income Portfolio, Capital Growth Trustee Portfolio, Global Fixed Income Portfolio, International 1 John Street Equity Portfolio, Mutual Fund Group, Mutual Fund Trust Millerton, New York 12546 and Mutual Fund Variable Annuity Trust; Partner in the law firm of Richards, O'Neil & Allegaert.
-23- Officers and Trustees Compensation - -------------------------------------------------------------------------------- NAME, POSITION AGGREGATE TOTAL COMPENSATION WITH THE FUND COMPENSATION FROM PAID TO TRUSTEES FROM THE FUND THE FUND AND FUND COMPLEX* - -------------------------------------------------------------------------------- John F. Donahue, $-0- $-0- for the Fund Complex Chairman and Trustee Thomas G. Bigley, Trustee $-0- $489.00 for the Fund Complex John T. Conroy, Jr., Trustee $-0- $2,001.50 for the Fund Complex William J. Copeland, Trustee $-0- $2,001.50 for the Fund Complex James E. Dowd, Trustee $-0- $2,001.50 for the Fund Complex Lawrence D. Ellis, M.D., $-0- $1,816.00 for the Fund Complex Trustee Edward L. Flaherty, Jr., $-0- $2,001.50 for the Fund Complex Trustee Edward C. Gonzales, President $-0- $-0- for the Fund Complex and Trustee Peter E. Madden, Trustee $-0- $1,517.50 for the Fund Complex Gregory F. Meyer, Trustee $-0- $1,816.00 for the Fund Complex John E. Murray, Jr., J.D., $-0- $-0- for the Fund Complex S.J.D., Trustee Wesley W. Posvar, Trustee $-0- $1,816.00 for the Fund Complex Marjorie P. Smuts, $-0- $1,816.00 for the Fund Complex Trustee * Fund Complex = Blanchard Funds, Blanchard Precious Metals Fund,Inc. and The Virtus Funds. MANAGEMENT SERVICES Manager to the Trust The Trust's manager is Virtus Capital Management, Inc. ("VCM"), which is a division of Signet Trust Company, a wholly-owned subsidiary of Signet Banking Corporation. Because of the internal controls maintained by Signet Bank to restrict the flow of non-public information, Fund investments are typically made without any knowledge of Signet Bank's or its affiliates' lending relationships with an issuer. The manager shall not be liable to the Trust, a Fund, or any shareholder of any of the Funds for any losses that may be sustained in the purchase, holding, or sale of any security or for anything done or -24- 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. Management Fees For its services, VCM receives an annual management fee as described in the prospectus. ADMINISTRATIVE SERVICES Federated Administrative Services, which is a subsidiary of Federated Investors, provides administrative personnel and services to the Funds for the fees set forth in the prospectus. DISTRIBUTION PLAN The Trust has adopted a Plan for Shares of the Fund pursuant to Rule 12b-1 which was promulgated by the Securities and Exchange Commission pursuant to the Investment Company Act of 1940. The Plan provides that the Funds' Distributor shall act as the Distributor of shares, and it permits the payment of fees to brokers and dealers for distribution and administrative services and to administrators for administrative services. The Plan is designed to (i) stimulate brokers and dealers to provide distribution and administrative support services to the Fund and its shareholders and (ii) stimulate administrators to render administrative support services to the Fund and its shareholders. These services are to be provided by a representative who has knowledge of the shareholders' 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 the Funds; assisting clients in changing dividend options, account designations, and addresses; and providing such other services as the Trust reasonably requests. Other benefits which the Fund 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 assets of shareholders by having them rapidly invested in the Fund with a minimum of delay and administrative detail; and (3) an efficient and reliable records system for shareholders and prompt responses to shareholder requests and inquiries concerning their accounts. By adopting the Plan, the then Board of Trustees expected 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 in shares 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. DESCRIPTION OF THE FUND Shareholder and Trustee Liability. The FUND is a series of an entity of the type commonly known as a "Massachusetts business trust". Under Massachusetts law, shareholders of such a trust may, under certain circumstances, be held personally liable for the obligations of the trust. The FUND's Declaration of Trust contains an express disclaimer of shareholder liability for acts or obligations for the FUND and requires that notice of such disclaimer be given in each agreement, obligation, or instrument entered into or executed by the -25- FUND or the Trustees. The Declaration of Trust provides for indemnification out of the FUND property of any shareholder held personally liable for the obligations of the FUND. The Declaration of Trust also provides that the FUND shall, upon request, assume the defense of any claim made against any shareholders for any act or obligation of the FUND and satisfy any judgment thereon. Thus, the risk of a shareholder incurring financial loss on account of shareholder liability is limited to circumstances in which the FUND itself would be unable to meet its obligations. VCM believes that, in view of the above, the risk of personal liability to shareholders is remote. The Declaration of Trust further provides that the Trustees will not be liable for errors of judgment or mistakes of fact or law, but nothing in the Declaration of Trust protects a Trustee against any liability to which he would otherwise be subject by reason of willful misfeasance, bad faith, gross negligence, or reckless disregard of the duties involved in the conduct of his office. Voting Rights. The FUND's capital consists of shares of beneficial interest. Shares of the FUND entitle the holders to one vote per share. The shares have no preemptive or conversion rights. The voting and dividend rights and the right of redemption are described in the Prospectus. Shares are fully paid and nonassessable, except as set forth under "Shareholder and Trustee Liability" above. The shareholders have certain rights, as set forth in the Declaration of Trust, to call a meeting for any purpose, including the purpose of voting on removal of one or more Trustees. The FUND may be terminated upon the sale of its assets to another open-end management company if approved by the vote of the holders of a majority of the outstanding shares of the FUND. The FUND may also be terminated upon liquidation and distribution of its assets, if approved by a majority shareholder vote of the FUND. Shareholders of the FUND shall be entitled to receive distributions as a class of the assets belonging to the FUND. The assets of the FUND received for the issue or sale of the shares of the FUND and all income earnings and the proceeds thereof, subject only to the rights of creditors, are specially allocated to the FUND, and constitute the underlying assets of the FUND. SHAREHOLDER REPORTS Shareholders will receive reports semi-annually showing the investments of the FUND and other information. In addition, shareholders will receive annual financial statements audited by the FUND's independent accountants. -26- APPENDIX A DESCRIPTION OF RATINGS Bond Ratings Moody's Investors Service, Inc. -- Bonds which are rated Aaa are judged to be 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 positions of such issues. Bonds which are rated Aa are judged to be of high quality by all standards. Together with 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 fluctuations 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. 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. Moody's applies numerical modifiers "1," "2" and "3" in each generic rating classification from Aa through B in its corporate bond rating system. The modifier "1" indicates that the security ranks in the higher end of its generic rating category; the modifier "2" indicates a mid-range ranking; and the modifier "3" indicates that the issue ranks in the lower end of its generic rating category. Standard & Poor's Corporation Bonds rated AAA have the highest rating assigned by Standard & Poor's. Capacity to pay interest and repay principal is extremely strong. Bonds rated AA have a very strong capacity to pay interest and repay principal and differ from AAA issues only in small degree. Bonds rated A have a strong capacity to pay interest and repay principal although they are somewhat more susceptible to the adverse effects of change in circumstances and economic conditions than bonds in higher rated categories. Bonds rated AAA by Fitch are judged by Fitch to be strictly high grade, broadly marketable, suitable for investment by trustees and fiduciary institutions liable to but slight market fluctuation other than through changes in the money rate. The prime feature of an AAA bond is showing of earnings several times or many times interest requirements, with such stability of applicable earnings that safety is beyond reasonable question whatever changes occur in conditions. Bonds rated AA by Fitch are judged by Fitch to be of safety virtually beyond question and are readily salable, whose merits are not unlike those of the AAA class, but whose margin of safety is less strikingly broad. The issue may be the obligation of a small company, strongly secured but influenced as to rating by the lesser financial power of the enterprise and more local type market. Bonds rated Duff-1 are judged by Duff to be of the highest credit quality with negligible risk factors; only slightly more than U.S. Treasury debt. Bonds rated Duff-2, 3 and 4 are judged by Duff to be of high credit quality with strong protection factors. Risk is modest but may vary slightly from time to time because of economic conditions. Bonds rated TBW-1 are judged by Thomson BankWatch, Inc. to be of the highest credit quality with a very high degree of likelihood that principal and income will be paid on a timely basis. Bonds rated TBW-2 offer a strong degree of safety regarding repayment. The relative degree of safety, however, is not as high as TBW-1. Commercial Paper Ratings Moody's Commercial Paper ratings are opinions of the ability of issuers to repay punctually promissory obligations. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rated issuers: Prime 1-Highest Quality; Prime 2-Higher Quality; Prime 3-High Quality. A-1 A Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues assigned the highest rating, A, are regarded as having the greatest capacity for timely payment. Issues in this category are delineated with the numbers 1, 2, and 3 to indicate the relative degree of safety. The designation A-1 indicates that the degree of safety regarding timely payment is either overwhelming or very strong. A "+" designation is applied to those issues rated "A-1" which possess safety characteristics. Capacity for timely payment on issues with the designation A-2 is strong. However, the relative degree of safety is not as high as for issues designated A-1. Issues carrying the designation A-3 have a satisfactory capacity for timely payment. They are, however, somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. The rating Fitch-1 (Highest Grade) is the highest commercial rating assigned by Fitch. Paper rated Fitch-1 is regarded as having the strongest degree of assurance for timely payment. The rating Fitch-2 (Very Good Grade) is the second highest commercial paper rating assigned by Fitch which reflects an assurance of timely payment only slightly less in degree than the strongest issues. The rating Duff-1 is the highest commercial paper rating assigned by Duff. Paper rated Duff-1 is regarded as having very high certainty of timely payment with excellent liquidity factors which are supported by ample asset protection. Risk factors are minor. Paper rated Duff-2 is regarded as having good certainty of timely payment, good access to capital markets and sound liquidity factors and company fundamentals. Risk factors are small. A-2 August 11, 1995 U.S.Securities and Exchange Commission 450 Fifth Street, N.W. Washington, D.C. 20549 Re: Blanchard Funds Blanchard Global Growth Fund Blanchard 100% Treasury Money Market Fund Blanchard Short-Term Global Income Fund Blanchard American Equity Fund Blanchard Flexible Income Fund Blanchard Short-Term Bond Fund Blanchard Flexible Tax-Free Bond Fund Blanchard Worldwide Emerging Markets Fund Blanchard Growth & Income Fund Blanchard Capital Growth Fund Registration No. 33-3165 ------------------------ Dear Sir/Madam: We are electronically filing via EDGAR, on behalf of Blanchard Funds ("Registrant"), and pursuant to the provisions of Rule 497(c) promulgated under the Securities Act of 1933, as amended, Registrant's combined prospectus for Blanchard Growth and Income Fund series and Blanchard Capital Growth Fund series, Registrant's combined prospectus for its other above-referenced series and each of the series' statements of additional information dated Agust 7, 1995. Very truly yours, Joanne Doldo cc: C. Grant Anderson Michael Freedman Beth Tafuri Susan Penry-Williams, Esq. -----END PRIVACY-ENHANCED MESSAGE-----